How Options Gamma, Vanna and Charm Flows Move the Markets
Summary
TLDRThis video script narrates the story of 'Gary the Gorilla,' a metaphor for market makers in the S&P 500 options market. It explains how option greeks—delta, gamma, vanna, and charm—affect market dynamics and the underlying stock market. The script uses a blend of humor and financial education to demystify complex trading concepts, illustrating how dealers' hedging activities can influence market movements, especially around options expiration.
Takeaways
- 🦍 The main character 'Gary the Gorilla' symbolizes dealers and market makers in the S&P 500 options market, highlighting their role in providing liquidity and taking on risk.
- 📈 Gary's delta hedging strategy is crucial for managing the directional risk of the options he trades, which requires constant rebalancing based on market movements.
- 🍌 Gary's love for bananas is a metaphor for liquidity, which is essential for his business and impacts the pricing and availability of options.
- 📊 Implied volatility and market liquidity are inversely related; abundant liquidity leads to lower implied volatility, while scarcity results in higher volatility.
- 📉 The client demand for out-of-the-money puts and calls influences Gary's position, often leaving him short out-of-the-money puts and long out-of-the-money calls.
- 🛠️ Gamma measures the rate of change of delta relative to the underlying asset's price, and it's significant for dealers like Gary as it dictates the need for rebalancing delta hedges.
- 📉 Vanna represents the sensitivity of delta to changes in implied volatility, affecting how much dealers need to adjust their hedges as volatility fluctuates.
- ⏳ Charm reflects the sensitivity of delta to time decay, with options losing value as they approach expiration, impacting dealers' hedging strategies.
- 🌐 The collective actions of dealers like Gary in delta hedging can have a substantial impact on the underlying market, especially with large open interest positions.
- 📅 The dynamics of gamma, vanna, and charm are particularly pronounced as options approach expiration, influencing market movements and creating potential windows of weakness.
- 🔍 Understanding these Greek dynamics can provide insight into market behaviors, especially around options expiration (opex), offering a framework to interpret S&P 500 movements.
Q & A
Who is the main character in the video script, and what does he represent?
-The main character is Gary, a gorilla who represents the dealers and market makers in the S&P 500 options market. He is responsible for providing liquidity to the market by allowing other players to trade options against him.
What is the significance of Gary's bananas in the script?
-Gary's bananas are a metaphor for the liquidity he enjoys in the market. The more bananas he has, the more liquidity he has, which is beneficial for his business as a market maker.
What does 'delta hedging' mean in the context of options trading?
-Delta hedging is a strategy used by options traders, like Gary, to neutralize the directional risk of an option's position by taking an offsetting position in the underlying asset. This is done to maintain a delta of zero, which means the position is not affected by small changes in the underlying asset's price.
How does the script describe the typical behavior of portfolio managers in the market?
-The script describes portfolio managers as being driven by both fear and greed simultaneously. They demand protection through options, such as buying out-of-the-money puts, while also looking to profit by selling out-of-the-money calls, which contributes to the market's dynamics.
What is the role of implied volatility in determining the price of options?
-Implied volatility is a measure of the market's expectation of the volatility of the underlying asset's price. It directly affects the price of options, with higher implied volatility leading to higher option prices and vice versa.
How does the script explain the relationship between liquidity and implied volatility?
-The script explains that when market liquidity is high, with many orders on both sides of the bid and ask, it is difficult to move the market, resulting in low realized volatility and therefore lower implied volatility. Conversely, when liquidity is low or one-sided, the market can be easily moved, leading to higher realized and implied volatility.
What is 'gamma' in the context of options trading, and how does it affect Gary's trading strategy?
-Gamma is the rate of change of an option's delta with respect to changes in the underlying asset's price. It affects Gary's trading strategy because when he is long gamma, like with out-of-the-money calls, he needs to sell more of the S&P index as the index rises and buy back some as it falls to maintain his delta hedge.
What are 'vanna' and 'charm', and how do they differ from gamma?
-Vanna measures the rate of change of an option's delta with respect to changes in implied volatility, while charm measures the rate of change of delta with respect to the passage of time. Unlike gamma, which is about changes in the underlying price, vanna and charm are concerned with changes in implied volatility and time, respectively.
How do vanna and charm influence the market during the approach to options expiration?
-As options approach expiration, vanna and charm can cause deltas to decrease, especially for out-of-the-money options. This can lead to significant rebalancing of hedges and can result in substantial index flows, potentially moving the index higher, particularly in the run-up to expiration.
What is the 'window of weakness', and how does it relate to the S&P 500 index?
-The 'window of weakness' refers to the period after options expiration when the stabilizing effects of gamma, vanna, and charm are no longer present in the market. It does not necessarily mean the index will crash, but rather that it is more susceptible to other market-moving factors during this time.
How does the script suggest that understanding these option dynamics can benefit market participants?
-The script suggests that understanding these option dynamics can help market participants explain some of the behaviors of the S&P 500, especially around options expiration. It can provide insights into market movements and potentially inform trading strategies.
Outlines
🦍 Introduction to Gary the Gorilla and Market Making
This paragraph introduces the main character, Gary, who is a metaphor for market makers in the S&P 500 options market. Gary provides liquidity for various market players and is responsible for delta hedging his positions. The paragraph explains how Gary's actions can influence the market due to his significant role in the options market. It also sets the stage for a deeper dive into the dynamics of options trading and the impact of market makers' positions on stock prices.
📈 Delta Hedging and Market Liquidity Impact
This paragraph delves into the specifics of delta hedging, a strategy used by Gary to manage the directional risk of his options positions. It explains how market liquidity, measured by the spread and depth of the order book, affects Gary's ability to hedge and the pricing of options. The paragraph also discusses the relationship between liquidity and implied volatility, highlighting that abundant liquidity leads to lower implied volatility and vice versa. The summary emphasizes the importance of understanding these dynamics for market participants.
🌟 The Role of Gamma, Vanna, and Charm in Options Trading
This paragraph introduces advanced option Greeks—Gamma, Vanna, and Charm—which measure the sensitivity of an option's delta to changes in the underlying price, implied volatility, and time, respectively. It describes how these Greeks influence Gary's hedging activities and the market's behavior. The summary explains that being long gamma can act as a market stabilizer, while Vanna and Charm can cause significant market movements, especially as options approach expiration. The paragraph also discusses the 'window of weakness' post-expiration, when the effects of these Greeks diminish, potentially leading to market fluctuations.
Mindmap
Keywords
💡Volatility Portfolio Manager
💡Option Greeks
💡Market Maker
💡Delta Hedging
💡Liquidity
💡Implied Volatility
💡Gamma
💡Vanna
💡Charm
💡Expiration (Opex)
💡Window of Weakness
Highlights
Jam Carson, a volatility portfolio manager, popularized option greeks such as vanna and charm and uses emojis to represent market forces in his tweets.
The video aims to demystify the greeks, the flows, and the emojis used in financial market discussions.
Gary, a gorilla metaphor for market makers in the S&P 500 options market, represents the dealers providing liquidity for options trading.
Delta hedging is a primary strategy for Gary to manage directional risk in his options trading.
Liquidity in the market is crucial for Gary's business, affecting his ability to hedge and the cost of options.
Implied volatility is directly related to market liquidity; abundant liquidity leads to lower implied volatility.
Portfolio managers' trading behavior influences Gary's book, often resulting in a short position in out-of-the-money puts and a long position in out-of-the-money calls.
Gamma measures the rate of change of delta in response to the underlying price, impacting Gary's need to rebalance his delta hedge.
Vanna quantifies the change in delta with respect to implied volatility, affecting how Gary's hedging strategy adjusts.
Charm measures the rate of change of delta over time, another factor in Gary's dynamic hedging strategy.
Long gamma positions act as market stabilizers, buying dips and selling rallies.
Significant gamma exposure can pin the index within a specific price range, demonstrating the dealers' market influence.
Vanna and charm flows are most pronounced during the second and third weeks of the month, affecting the S&P index's movement.
The week of options expiry (opex) sees a decrease in vanna and charm effects, opening a window of non-strength for the index.
Post-opex, the absence of vanna and charm flows means the index is more susceptible to other market-moving factors.
Understanding these option-related flows can help explain some dynamics of the S&P 500, especially around opex.
The video concludes by emphasizing that these market dynamics are not an exact science but understanding them can be valuable.
The narrator hints at future videos covering other financial topics, such as 'lemons', encouraging viewers to subscribe.
Transcripts
gorilla's bananas are you serious is
this is this for real
how do i even present this
and when gary cannot get his bananas oh
that makes him very angry
and that's when prince charming comes
around and opens a window of weakness i
can't i just can't do this
you're probably wondering what was that
all about
i understand because even if you've been
following financial twitter you might
not necessarily be familiar with jam
carson jam is a volatility portfolio
manager and is famous for popularizing
such option greeks as vana and charm
when he shares his market views on
twitter he often discusses option
dynamics and the impact they have on the
underlying stock market but what makes
him different is his unrestricted use of
emojis his tweets often feature
different emoji characters which
represent various market forces if
you're not familiar with these market
forces or emojis it might be difficult
to understand what is going on
in this video we are going to demystify
the greeks the flows and the emojis and
discuss how dealer option positioning
affects the underlying stock market
let's get into it
[Music]
hello and welcome sergey here on this
channel you'll find many educational and
hopefully entertaining videos covering
various topics within the incredible
world of financial markets if that
sounds like something you're into please
subscribe to the channel it'll be great
to have you on board
so
let's start the story
enter our protagonist he's good looking
he's gorgeous he's golden age is a
proper handsome
his name
is gary his name is gary
gary is a dealer
he is the market maker in s p 500 index
options he makes it possible for hedge
funds pension funds portfolio managers
and other market players to trade their
options against him
he provides liquidity
oh and he's also a gorilla
[Music]
metaphorically gary represents all the
dealers and market makers in the s p 500
options market quite a massive chunk of
s p options volume goes through him
he's a big gorilla i mean look at him
he's a real risk taker once someone
trades options with him it's very rare
that gary can make the same offsetting
trade against someone else after all
he's not a broker it's great when it
happens but most of the time he's just
left to sit there on the risk and
warehouse it on his books
so the first thing gary does is to delta
hedge and remove the option's
directional risk he hits es1 index mdm
go on his bloomberg and checks the order
book and it looks fantastic tight spread
on the best bit and offer lots of quotes
on both sides and with decent size too
there is some good market depth in there
gary likes what he sees
all that liquidity means that he'll have
no issues hedging his delta in either
direction
that's good for business it is good for
business with delta hedging not an issue
gary can afford to sell the options
cheaper and make more volume
equally when buying options he wouldn't
pay for them more than he can recover
from delta hedging them especially since
it's difficult for the index to make any
meaningful moves with so many quotes in
the order book
and so he remarks the entire wall
surface lower as you can see from this
example it is often that implied
volatility directly reflects the market
liquidity if the liquidity is abundant
there are many orders in the order book
on both sides of bit and ask
if a large order comes in it'll be
easily observed by the market and won't
have a significant price impact
hence it is very difficult to move a
liquid market
as a result realized volatility will be
low
which will also be reflected in a lower
implied volatility
on the other hand if the liquidity is
inadequate or one-sided
the order book will be thin
and any relatively large order can
easily move the market
this will result in a higher realized
volatility and consequently in a higher
implied volatility
to summarize as liquidity deteriorates
implied volatility moves higher
or as liquidity improves implied
volatility
falls
and gary likes his liquidity like he
likes his bananas the more he has the
better it is
and on this quiet summer day he's got
lots of bananas
[Music]
but even during the summer all those big
portfolio managers are keeping gary very
busy
it's usually said that it's either fear
or greed that dominate the market at any
one time
but with portfolio managers it seems
that both of these emotions are dominant
simultaneously somehow they manage to
manifest themselves within a single
individual as a result gary's client
overflow usually takes shape in the form
of downside buying and upside selling
everyone wants protection but at the
same time everyone wants to make some
extra money anywhere they can
in part to help pay for that same
protection as it ain't cheap
as a result of this flow there is lots
of demand for out of the money puts and
quite a bit of supply of out of the
money calls
consequently the dealer's book is mostly
short out of the money puts
and long out of the money calls
this of course needs to be delta hatched
which forces gary to sell s p index for
both
the put side and the call side
this way any positive delta from the
option's position is offset by the
negative delta from the short s and p
position resulting in an overall delta
of zero
after the book is hedged gary's got a
minute to grab a quick coffee and a
croissant but he's not done what matters
now is how the delta changes as it moves
around gary will need to rebalance his
delta hedge by trading in the underlying
and this trading activity is not
discretionary he is completely at the
mercy of his delta in order to stay
delta hedged he must trade the s p as
directed by his delta changes and keep
in mind gary is a big gorilla he
controls a significant portion of snp
options flow his delta hedging activity
is far from trivial the rebalancing
flows are meaningful and frequently
impact the underlying market
wouldn't it be great
to know in advance what these flows are
going to be
the size and direction of these flows
depend on how much dealer's delta
carries delta wanders around and that in
turn depends on changes in underlying
price changes in implied volatility and
the unstoppable marching of time that is
slowly guiding us all towards an
inevitable death
the effects of these quantities are
measured by gamma vanna and charm
respectively
gamma is a change in delta with respect
to underlying price
vomit is a change in delta with respect
to implied volatility and charm measures
the change in delta with respect to
passage of time
okay here's the big picture at the
moment if it's a quiet summer day and
the market has been slowly grinding
higher
gary finds himself sitting around this
long out of the money calls territory
where he is long gamma
if the index rises his options delta
will increase towards 1 as options get
closer to the money
and he'll need to sell more of the s p
index in order to counter that
on the other hand if the index falls
his options delta will decrease towards
zero as options get further out of the
money and he'll need to buy back some of
his s p shorts in order to offset this
tightly packed isobars on the northern
flank of that means easterly wind in
summary if the dealers are long gamma it
means that they're buying the dips and
selling the rallies which acts as a
stabilizer for the market
and if the long gamma exposure is
significant for example a large open
interest
it works as a magnet and pins the index
around a certain price range
[Music]
as we move towards options expiry week
the gamma for at the money options
increases significantly and can further
dampen the index moves apart from
gamma's stabilizing flows there are also
vana and charm flows
for out of the money options delta moves
towards zero as implied volatility drops
or as the option approaches expiry
under normal market conditions implied
volatility term structure is incontango
and is upwards sloping this means that
for a slightly out of the money option
we would expect its implied volatility
to decrease as the option approaches
opex it would just roll down the term
structure
and this change in implied volatility
causes delta to decrease as measured by
vana
[Music]
but vana is not the only thing that
decreases delta there is also charm
as we get closer to expiry out of the
money options become cheaper and their
deltas tend to zero
together with vana charm is guilty of
lowering deltas as options approach
their due date
and since gary's positioning is mostly
long are the money cause a lower delta
means he needs to rebalance his hedge
and buy back some of his s p shorts now
i say some but given the size of his s p
options book buying some s p index can
in fact result in quite significant
index flows and move the index higher
especially in the run-up to opex the
effects of varna and charm are the
strongest during the second and third
week of the months as in the opex week
and the week before
these flows are frequently guilty of a
slow grind higher that we usually see in
s p index in the run up to opex
as we move towards the middle of the
opex week the vana and charm flows start
fading away part of these flows come off
the table when we hit the expiration on
wednesday making an opening for the
window of weakness
after the opex gamma vana and charm
expire
and the index is free to do
whatever it is that indices do when
they're not subjected to options hedging
flows
this is when vana and charm go on a
holiday and their flows aren't present
to support the market
however the window of weakness does not
necessarily mean the index will crash
it's not a window of weakness it's a
window of non-strength and that just
means the index has stopped flirting
with vana in charm and is open to other
relationships hence it's more
susceptible to other market moving
stories during this time
at around the end of the months vana and
charm start coming back and begin having
an effect again
well that was the story of gary
thanks gary of course these dynamics and
flows aren't an exact science they
largely depend on dealer positioning
where open interest is what level the
volatility is at and how much is it
moving
nonetheless understanding these flows
can help explain some of the dynamics of
s p 500 that we see around opex
[Music]
thank you very much for watching i
really hope you enjoyed this video apart
from bananas i'm also planning to cover
such things as lemons in my future
videos so if you want to see that please
hit the subscribe button thank you very
much i'll see you in the next
[Music]
one forget to like and subscribe
[Music]
sweetie
[Music]
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