What Is a Gamma Squeeze in the Context of Stock Trading?
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1) buying cheap far out of money, near expiry naked puts or calls (gambling)
2) selling cheap far out of money, near expiry puts or calls (taking out a loan from the mob to pay yourself a salary)
3) a combination of the above but with varying expiration date and strike price (limited risk, low payout, essentially grinding)
Different market conditions have different strategies, you can make money in any type of market whether it trades flat, bull or bear.
Probably the most popular method is people selling essentially insurance to gamblers from #1. There's just no way that the market can crash overnight right?
You have to be lucky every time and the market needs to be lucky only once to end your trading career.
Looking back, I think buying stocks or index is really best for passive investors. If you want to spend a lot of time learning and trading options its going to become a full time gig.
One of the most common I’ve heard from regretful friends is a variation on your scenario #1 where they buy a deep OTM call a few weeks out right after a recent pop in the underlying. Maybe the rally continues a bit, underlying goes up in price, they’re clapping themselves on the back. A few weeks pass and the price has gone up a bit more, but the options position is already blown up.
“I don’t get it... the stock price went up and everything but I still lost all my money on options.”
Worse still, due to the leverage offered by options, the losses can sometimes be real bad.
They've figured out a way to get people who shouldn't be trading options to gamble online.
So yes if you think Tesla is going to be $1000 in a few weeks and it moves towards that direction but not enough to make up for other greeks, IV, theta, etc, then yeah it could happen.
I think the problem with a lot of these is that you can think about how the strategy might work for a couple minutes. Then you think it must be a good strategy, because it's complicated to you. This is a very common fallacy I've noticed reading about "options strategies" by extreme amateurs: because the options strategy is complicated, I am smart for understanding it (at a basic level) and thus it must be a good strategy. They don't hold up to scrutiny:
"I'll just sell 10% OTM weekly calls on this stock until I get assigned, then I'll sell OTM puts until I get assigned again." -> You can lose money selling puts. Pays less than investing in the S&P 500 unless you pick a stock with high volatility, which is more likely to hit. No free lunch.
"I'll sell covered calls on SPY and if they get close to expiring ITM, I will buy back the options and start over" -> If you backtested this, it performs worse than holding SPY. You won't backtest this though, and feel smart for spending so much thought on a losing strategy.
"I'll enter some hideously complex, multi-leg position. Because it's complex, and I'm smart for understanding it, it must be good." -> No.
"I found an arbitrage opportunity." -> If you're not using computers, 99.99% chance you didn't. If you did, it's probably very small. Or it's due to some misunderstanding like the fact that American options can get exercised early.
THIS. so much this.
I admit I fell into this trap after reading about iron condors. "I can print money now from home" I thought, "omg I am so smart creating these exotic positions".
but I am thinking what if you were writing LEAPS. We've been in the longest bull run in history since 2009, so you could've made a lot of money selling LEAPS until maybe 2020 where you would blow up your account and end up owing more than your balance.
Also another area that I could never find an answer on: i was told most traders never excersie their options. so if you sell puts and they never exercise you don't have to deliver the stocks right? you just end up paying what the options market price is on the day the reputable stock dips?
What you were actually told was probably that most options expire worthless.
Actual worst case is the underlying pops and you “only” get the premium you collected and not the full upside.
So definitely not a profit maximising strategy but still a reasonable one. Especially if the market/underlying are generally moving sideways.
I don't know exactly how it happened but someone on wallstreetbets a while ago said he woke up to find he was -250% and asking what to do. I assume he wrote bunch of options which ran against him.
It's disturbing because I talked to this kid literally a week before I told him I blew up my account buying far OTM puts (I was right about the price but SEC froze the stocks far past the expiry).
I will semi-regularly sell puts with a reasonable expectation of being assigned. It is in effect the same as putting a limit order in, with the upside of getting paid for doing it.
Selling covered calls can be a fine substitute for limit sells if used carefully. Assuming one is comfortable selling at the strike price, the covered call trickles a little profit in the meantime.
1. New information comes to light, the stock crashes, and you realize you were wrong and the stock is a dog. You no longer want to own it at the strike price. Oops. You effectively bought it above your updated estimate of its worth.
2. The stock keeps rising and rising, you collect the option premium but you could have made a lot more money if you just bought the damn thing outright.
These are more subtle failures than the usual "Oh my God, I blew up my account!" but they're real.
It's perfectly fine to keep doing what you're doing if you're comfortable with this risk. There is no strategy without a downside.
Also if you believe just buying the S&P 500 is going to be most profitable, then why not buy deep ITM calls on SPY. You'd at least 2x your exposure at the same cost.
Because time. Options expire, shares don't. When you own shares, time is your friend — if the market goes down and you still believe your thesis holds, just wait. When you own options, time is your enemy. Should anything happen at just the wrong time, you have no choice but to take a hit.
Exactly this.
A friend of mine (PhD, smart guy, excellent programmer) called me for advice and his argument was - I am smart so surely I will find some unique opportunity in the markets.
And my answer - You don't believe but there are hundreds of thousands smarter people with deeper pockets...
Be humble...
Even if he is much smarter than all the quants at Goldman, they do this for sixty hours a week in a context where time matters a lot. That was the
I will say that the efficient market hypothesis is probably overrated when it comes to an area where you have expertise; I used to make a bit higher than SPY or the Nasdaq by trading tech stocks on big movements (which are often insane), without using any insider info[1]. But the delta just wasn't worth having to spend my mornings looking at the markets so I didn't miss any trades, and I liked my day job a lot more.
"A Mathematician Plays the Stock Market" by https://en.wikipedia.org/wiki/John_Allen_Paulos#Bibliography
for me trying to determine the timing AND the price target was stressful as hell. Like every morning my heart would beat rushing downstairs to check my tendies.
in the end what screwed me was the SEC. There is just no way to predict how long a stock will be halted. I also learned that in a class action lawsuit, option traders are pretty much unable to recoup their money in a fraudulent company (although I do appreciate the SEC sending me the letters, the rule of law is taken very seriously, scammers almost always see the inside of a jail).
Suppose you sold puts on Verizon at 55. You are on the hook to buy Verizon at 55. If you have 5500 in equity, you're fine. You get the stock and hold it, perhaps wheel it.
But if all you do with $5500 in account equity is sell a single put contract, you wont make much money. So most people sell more than they have equity to support. So perhaps you sell three Verizon contracts. Your $5500 in account equity is now on the hook for 3*$5500. If Verizon stock goes down to 36, you are wiped out.
Oh, and all this while, you arent capturing any of the Verizon upside either! You only get the premium.
I've always thought buying deep ITM was more like holding leveraged stock and nice for that conceptual reason, but what's the advantage/disadvantage of buying OTM options (in contrast to ITM)?
I've read money managers use far OTM options to hedge against a potential shock (high confidence in bad earnings) but you also stand to lose your premium.
Nassim Taleb, Black Swan author, runs a fund that consistently buys far OTM options. They lose money most of the time until that one time where they strike it big. As he describes in "Random Walk in Wallstreet", he cleaned up his desk on the trading floor on Black Monday when his far OTM puts he bought for pennies on the dollar turned into double digit million figure. This is how he made his FU money and has been the subject of emulation by amateurs and professionals alike.
But then you look at people like Jim Chanos who shorted Enron successfully but have not been able to crush Tesla. Had he used options, he would've not only saved a lot of capital, he would still have his skin left in the game.
Not sure I undrestand your second question but I assume you mean near strike OTM vs deep OTM. You have to pay a premium for near strike options or if its in the money.
So basically you're saying that you can "leverage" more with OTM than ITM?
OTM is cheaper but much more riskier because your stock has to travel further.
No you would leverage more with OTM because you can buy a lot more OTM with the money you spend on ITM.
This is a gross generalization, when I say "riskier" it is purely from an academic point of view. In reality there are so many other factors at play, fundamentals, theta, delta, vega, etc. I can't really explain it because I don't understand their exact relationships but in general when you have an option position the clock is against you and so many other factors that has to go right.
It's like in Casino Royale when that Marilyn Mason look-alike invests African warlords money on an airline company on far OTM near expiry options and then launching an attack in the airport.
The SEC has a safeguard against these things. If you have large far OTM options near expiry and the stock dips the next day, expect a visit from the SEC or FBI.
This answers my question, thank you. The piece I was missing was the difference in the amount OTM vs ITM needs to move, thanks
From a strategy/risk management perspective, for sure.
Upsides with deep ITM calls is you'll pay less of a time premium and mitigate some effects from volatility. It can also be a "cheap" means for covered calls.
As for downsides - larger upfront risk as well much less liquidity / greater chances of an order not being filled.
Buying many OTM calls can be more or less a gamble.
THIS. THIS. THIS.
I remember calling Interactive Brokers panicking because I couldn't dump my position since there was no counter party at the deep OTM strike.
However, even then, it's not even close to being my best option because the tail risk, however small, is there — and when things come down to the wire I'm going to get ulcers, win or lose.
Albeit, if you actually do want to sell or buy at market price (and are patient about it), you can use option premiums to get just a little bit more money for something you were already going to do (the goal being to get assigned, on purpose).
assuming you risk 10% on your broker's account with 90% tied up in fixed income or t-bills or stocks.
assuming you stand to make 100,000 USD per month selling far OTM options presumably on indices or blue chips.
you are worth $10 million and above.
I guess when they give you better rates than any retail banks this makes sense....
but I'd feel nervous even with 2FA.
With cash, I prefer to put it in Marcus, but their rates have really gone down so much I need to look into private banking.
That's the classic picking up pennies in front of a steamroller trade. You'll make $100k a month for a few years and then one day you will lose $10m in a single day.
It's not for everyone. But with proper risk management and mindset, it's not a casino either.
Common sense rules: Only play with risk capital (what you can afford to lose). Don't go all in WSB style, that's the surest way to blow up your account. Don't FOMO chase, wait for the right setups, look at support and resistance levels. Take profit incrementally. Use stop loss. etc, etc.
I'm guilty of taking advantage of this myself, as there are often plays (Tesla, Gamestop etc) where the conditions are often perfect for such a squeeze. WSB prides itself on buying ridiculously OTM weeklies and losing money, except this time there's enough collective power to force market makers into buying the underlying and "mooning" is inevitable. Case and point, I bought the furthest OTM TSLA 1/15 calls last Thursday and sold on Friday for nearly 1100% returns.
Market conditions right now are enabling boundless opportunity. It's best to take advantage, before the SEC steps in and puts restrictions on retail options trading. "Make hay while the sun shines"
1. Options have asymmetric payoff. One way you win, the other way you don't lose, assuming you are the buyer. The opposite is true for the seller.
2. Because of the asymmetry, movement is positive for the owner. So the option is priced based on how much movement is expected. There's a distinction here between vega and gamma, which are both movement related. Vega is sensitivity to the appraised future volatility, which means the option has more of that if it's long dated. Gamma is (2nd deriv) sensitivity to movement in the current price, so you'll have more of that if you're near the expiry.
3. As an options market maker, you are not in it to guess which way the underlying stock goes, you are in it to gain an edge in pricing that movement risk. So you hedge it when you trade an option with someone. If you buy a call, you sell some underlying so that your delta is flat. (Delta is just the 1st order price sensitivity)
4. If you flattened your delta, you can imagine the gamma making your local PnL vs price a parabola. If you are long the option you'll make money when the price moves either way, and you'll be needing to buy low and sell high to get back to flat delta. (Incidentally this is also why we don't really care whether it was literally a put or a call, as in the right to buy or sell. The 2nd order is the same, so has the same effect on your PnL when the price moves.)
5. The opposite is a less nice position to be in. The more the price moves, the more wrong your position is. In fact, the more it runs away, the more you have to push it the wrong way, because you'll be selling into a falling market or buying a rising one.
6. Natural question is, why would anyone ever be short gamma then? Well, you're going to charge people for their gamma, and if things turn out right you'll have charged them more than it's worth in terms of potential movement that they can buy low and sell high on.
7. So what happens with squeezes? Well sometimes that gamma gets so out of hand, there's some player with a huge wrong position squirming to flatten his position, but he is pushing it further and further away with each trade. Note that near expiry, a lot of things get hairy. You can imagine the gamma gets really spiky near the strike, because the time value is coming out of the price, and so you have a discontinuity at that corner. Also with binaries, knock-outs, and other simple non-vanilla options, you get some weirdness that can momentarily cause some large sensitivities. I've seen more than a few days where someone is defending some level and the price action looks odd.
8. Isn't the pressure the opposite for someone else somewhere? Technically yes, but often incentives are not the same for different agents. Different players have different risk tolerances, and they have different business models. For instance if someone has taken a load of options and shoved them into a structured product, maybe they're not quite as worried about hedging it as someone who doesn't have that customer flow. Or someone just has some cash to take a punt on the option, and they don't care if it expires worthles. Remember it's not just the two people who traded the option, there's the market in the underlying as well. Interestingly that means you can trade an option with me and we can both make money.
I've been wondering if Elon's TSLA comp package was designed with this in mind. It really would be perfect SEC like move.
1/ Vega is sensitivity of option price to change in level of implied volatility. Appraised is an unusual word choice.
You'll have more gamma if the asset price is near the strike price of the option. But gamma can actually be lower near expiration for the same strike if its fairly out of the money - gamma will only be higher for at/near the money options.
6/ Market makers buy and sell volatility and outside of retail, prices are usually quoted in vol terms. That's not to say that professionals can't do some crazy things trying to hedge risk, including theta (time) and rho (interest rates) but the original trade is a vol trade first and foremost.
My slightly different explanation: Delta is the 1st deriv change in price of the option wrt the value of the underlying asset. Gamma is the 2nd deriv, ie the rate of change of delta. As expiration approaches, gamma gets very like a dirac delta function, centered at the strike price. Easy to understand - moments before expiration a call option value is either worthless or exactly (Underlying - Strike price) Thus a delta of either 0 or 1 (-1 if you are short) with gamma equal to delta.
As the original poster explained, traders hedge by buying or selling the delta amount of the underlying (if delta is 0.5, you do 50% of your notional contract size). As the underlying moves, the short trader needs to buy when the underlying rises (his negative delta is increasing) or sell when it falls (his delta is decreasing so less hedge needed) to maintain a 'neutral' position wrt to small changes in the price of the underlying.
Recall, gamma is the rate of change of the delta and so determines how much the hedge needs to change. On day of expiration at the money strikes have very high gamma and thus subject the short option trader to large whipsaw risk - the need to add or remove a hedge aproaching 100% while chasing the underlying. The art is really in deciding when to hedge on/hedge off and how much, regardless of the formulaic delta and gamma values at the current underlying price.
As for "appraised" that's an invention of mine to explain the difference between actual movement and guessed movement. When the market is moving up and down you will realize some amount of PnL regardless of what you paid for it. But you have to pay something for it, and that's the appraisal of the market for whatever period in the future your option covers. It's like pricing a swap, that floating leg will be some number that you'll receive, but you pay some guess about what it's going to be over the period. The thing about that is you probably have more certainty in the near term than the long term, and there's a term structure coming out of that.
About quoting in vol terms, I found people mostly do that in FX and fixed income. In equities it seemed to be prices. There's calculators for everything anyway, so you can easily swap between them.
1) Are options market makers mostly long or short gamma, and does this tendency differ if we're talking about puts versus calls? I know this can all vary over time, but I'm wondering if there's any systematic tendencies here, especially pertaining to index options.
2) Do you think gamma hedging drives a significant percent of volume in index futures (say 5% or more), or is it just a trivial %?
3) What would be a good way to estimate/approximate the gamma exposure of options market makers if we wanted to predict gamma squeezes, and we've only got public market data (e.g. trades and open interest)? SqueezeMetrics advocates using open interest but I'm wondering if there's a better way to do this.
4) Compared to delta & gamma hedging, do any of the other greeks (e.g. vanna) drive a significant percentage of volume in in the underlying in certain contexts, or are they mostly a side show?
2) I think so, firms I worked for threw around a fair few index futures to hedge. quantifying it isn't too easy though. A lot depends on how close you are to the strike and the expiry.
3) You can't avoid looking at open interest, but I guess you can weight it by the gamma.
4) Vanna is a cross greek of vol and price. The other missing piece is interest rates, and from that you can imagine a zoo of greeks. But mainly it's the connection between vol and price that matters, there's a slidey thing you use to move the volatility surface when the price moves.
I guess if I were you I'd scrape all the open interest info and see about the relative size of presumed gamma to liquidity in the market. It's a bit of an exercise.
(1) and (3): If we're to use open interest (along with the gamma of such open interest), it seems that we have to make specific assumptions about whether options' market makers are going to be net short/long, and by how much, in each specific contract, in order to perform the calculations. What such assumptions do you think that we should use for that, and I wonder if there's a way to make it more accurate than simply assuming "100% of this open interest in this specific put is held short by options market makers"? That seems to be the assumption made in [1], which is definitely very incorrect but maybe it's the best we can do?
(4) So I guess flow that results from vanna hedging (and the other greeks aside from delta/gamma) is pretty small then. A number of people on Twitter make a big deal out of vanna hedging - they seem to think it can predict moves in the underlying, but they must be mistaken if not much flow comes from it as a result.
The squeezemetrics people seem to have quantified it, it's actually quite impressive. The GEX and VEX thing seems to be what you are alluding to, and they seem to have crunched the numbers.
Browsing the papers it seems they assume that the customers are selling the calls and buying the puts? I think it makes sense, it's more sensible than saying all the open interest is one way on the market makers.
Puts are where it is likely to be just market makers on the short side - lots of insurance buying but few nakeds or covered shorts.
I know you referenced "good feel for the underlying and market participants" in order to answer that question, but I'm wondering if there's a specific idea you could suggest regarding that to help narrow my focus?
> It is not just market makers that sell calls
Would you guess that market makers are, on average, net flat, net short, or net long calls?
Is there a guide to all this sort of stuff? What do tell the newbies? It's really hard to find good information about trading of the enormous amount of spam out there.
As for a guide yes it's hard due to all the get rich quick adverts. Perhaps read Wilmott to get an overview of how things are priced.
The code is here: https://github.com/FinancialMarkets/5MinuteFinance/tree/mast...
Thread of other resources on derivs: https://twitter.com/bennpeifert/status/1238823808946954241
Can you explain this? Maybe I just need an example to understand how this works
You did nothing in the meantime, so you collected the premium on the expired option.
Note this system isn't closed, we have not accounted for where the money came from. The market makers in the underlying are out the amount of the hedge gains.
If you're a whale, sure you can make brokers squirm by throwing your money around to buy a ton of options, forcing said brokers to bid up the underlying price hedging their short calls.
But then (as the whale), while the price is high you'd want to close some part of your position and realize gains. This means you sell the underlying at the inflated price, and then re-buy it at the lower price by exercising your call options? Is that the strategy?
As you're in the know, would love to see how you would contextualise your examples on GameStop (GME) this week which is all over r/wallstreetbets.
As a lurker it has been quite the case study to observe - the OI for calls and puts are absolutely insane. Is this normal? What would the option writer be thinking/doing? What would the option owners be thinking?
Allegedly one fund took out a single 50k deep ITM position in a put that could possibly even expire OTM. The tinfoilers believe this was an attempt to deliberately induce selling pressure via these gamma squeeze mechanics you've mentioned.
This world is deep, never would have realised so many layers were going on under just a stock price...
The share is super volatile and can swing 15% in a day - how do option writers hedge in these situations?
Before making a price they will consider multiple factors, liquidity (of the underlying and the derivative) is an extremely important one. They likely will not carry a trade that is impossible to hedge (because the underlying is not liquid enough).
My point is that a market maker will not carry an option position that is impossible to hedge due to the underlying liquidity. In other words, he will not carry a gamma position that is not "in line" with the liquidity of the underlying.
I may be wrong, but the article is about buying a lot of short dated (high gamma) call options from a market maker and hoping that he will drive the market up while hedging his position.
In a less traded issue - I guaranty the real price is not $0/$5, it is just nobody has bothered to show interest yet (and sometimes brokers do not provide the true market). Assuming you have a reasonable idea of where the bid should be, low ball it a little and put an order in. Like magic, you'll be joined by a few hundred contracts and in fact, probably out bid. An offer may also appear too.
Someone please correct me: can't gamma (the second derivative) be a constant, implying delta (first derivative) is linear? Then the price itself changes quadratically.
The process is nonlinear, necessitating a quadratic taylor expansion, at least.
2. Market makers sell these calls, and so buy TSLA shares to cover their position.
3. Due to #2, TSLA shares appreciate, as well as the calls from #1.
4. Retail investors see all the money being made, and FOMO in to buy more calls; go back to #1, repeat.
Unless there's some significant news or M&A deal that you can tie to price action (and even then, you're most likely explaining only part of the price movement), you won't know why a price is moving.
There is a whole industry of people adding post-hoc rationalizations to price movements (e.g. CNBC, stock gurus and others). They do it because 1. what they say is not falsifiable in any way and 2. people find idle speculation about money to be exciting.
I think it's right to point out "on any given day". On broader time horizons you can easily figure out why prices move and you can bet on it much easier.
> The RSI is trading above 70. This could mean that either the stock is in a lasting uptrend or just overbought and that therefore a correction could shape (look for bearish divergence in this case).
The price might go up if it doesn’t go down? Thanks, very helpful.
So, they're predicting both sides of movement because they're interested in the slope of the trendline dividing those sides and the time-frames they're analyzing, not the sides themselves.
One example that clarified it for me is a purely degenerate case, the stock went from 1 to 0 over all possible timeframes. In that case, all trendlines are purely vertical, all trendlines are the same for all timeframes, so the fact it can only move up is obvious, and contrasting trendliness is uninteresting.
However, in other cases, (say, a small medical research company that has been on the market for a decade but recently produced the singular vaccine for a massive pandemic, but has an expensive and novel manufacturing process that makes it 5x the cost of competitors possible solutions), contrasting trendlines for the last two months versus last decade is very informative for comparing the case in which the vaccine market becomes competitive, versus the monopoly it "is" today.
Noting the signal we'll receive about the 'class' of price movement, based on both directions the price could move, is very helpful and necessary for judging the TA after the time period plays out.
The retail investor gets long an option (let's say a put), and the dealer gets short that option. As the price goes down, the retail investor gets shorter (higher chance his put finishes in the money), whereas the dealer gets longer.
In general, retail investors don't hedge, whereas dealers do. As the stock price goes down, the dealer needs to sell stock to hedge and avoid getting net long the stock. Thus a gamma squeeze tends to exacerbate rather than mollify volatility.
This gives rise to a phenomenon known as pinning where stocks prices tend to oscillate around strikes with high OI and thus high convexity.
The simple reason is that like delta, gamma is also not constant. Gamma is our derivative of delta with respect to underlying, but there exists another measure called speed which is the derivative of gamma with respect to underlying (gamma of gamma). This is normally distributed around the strike price of the option, so as you deviate from the strike, the gamma of an option decreases which means that MM hedging decelerates as you move away from the strike. It also means that MM hedging accelerates as you approach the strike. Convexity cuts both ways.
Let's say a MM is short a $100 call in some asset X. When we are below $100, any move towards $100 means we have to buy increasing amounts of X in order to remain delta neutral. This pushes prices towards $100. But as we move through $100 this force decelerates. So let's presume that market momentum takes us to $110, at this point, a $1 drop to $109 results in more selling than an increase to $111 results in buying. These forces can become self fulfilling whereby the selling that we have to do when we drop from $110 to $109 contributes to downward pressure and pushes us to $108. And recall that our hedging accelerates as we move towards the strike. So we have to sell even more now than we did before, which further contributes to downward momentum. This pressure peaks at $100 at which point is starts to decelerate again, providing a natural tendency to revert to high OI strikes where there is substantial outstanding gamma.
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When the banks buy stocks to hedge their calls, they push the price up. Why does that create a feedback loop?
Because the price going up makes each call more risky, which means they need to buy more stock for each call on their books (including the ones they already hedged).
That effect, the relationship between the price of the underlying and how much you hedge, is "gamma".