How To Interpret Periscope Net Gamma Exposure
How do I set up the SPX Market Maker Exposures chart for today’s gamma exposure profile?
Navigate to the Periscope > Market Exposure page here: https://unusualwhales.com/periscope/market-exposure. Then, in the upper-right corner, select today’s date and “Gamma” from the side-by-side dropdowns:
What do the gamma bars represent?
Each gamma bar on the right-most “profile” plot represents the net Market Maker gamma exposure at that strike price.
If negative (red and to the left), Market Makers are net negative gamma at that strike, and if positive (green and to the right) it means Market Makers are net positive gamma at that strike.
But what does net negative vs. net positive actually mean?
Net Negative Gamma
Net negative gamma means that Market Makers are net short options at that strike. This does NOT mean that their counterparties, who we will refer to as “customers” for the rest of this article, are bearish or bullish! Re-read these two sentences a few times because this concept is absolutely vital.
If customers are net buyers of options, then Market Makers are net sellers of options. Put vs. Call does not matter!
Consider a customer buying one Put from a Market Maker. The gamma of a long Put is positive, so the customer’s Put purchase results in a positive gamma position. The Market Maker was the seller in this transaction, so this Put sale results in a negative gamma position.
The gamma of a long Call is also positive, so a Customer buying a Call from a Market Maker results in the same negative gamma position.
So in summary, if customers are net buying options (Puts OR Calls), the Market Maker on the other side of that trade has negative gamma exposure.
Net Positive Gamma
Net positive gamma means that Market Makers are net long options at that strike. And just like the net negative gamma scenario above, positive gamma is not an indication of customer bullishness or bearishness.
Put vs. Call is similarly inconsequential here. When customers are net selling Puts, the Market Maker will have a positive gamma position, and when customers are net selling Calls, the Market Maker will similarly have a positive gamma position.
An Empirical Note on Moneyness
Trading in SPX (and SPXW) is primarily done out of the money (“OTM”).
Delta Hedging Market Model
“Essentially, all models are wrong, but some are useful.”
--- Box, George E. P.; Norman R. Draper (1987). Empirical Model-Building and Response Surfaces, p. 424, Wiley. ISBN 0471810339.
The primary role of an options Market Maker is to “provide liquidity”, a fancy way of saying “sell to buyers and buy to sellers”. This role allows the Market Maker to sell on the offer and buy on the bid, collecting the spread between customers who wish to buy and customers who wish to sell.
Buyers and sellers are rarely in perfect equilibrium though, so the Market Maker ends up with some inventory of options. This is where we arrive at the key assumption: the Unusual Whales naive delta-hedging market model assumes that Market Makers will hedge the directional risk of this inventory by buying or selling E-mini S&P futures contracts to bring their net exposure to zero.
This technique is commonly called “delta hedging”.
Delta Hedging: Negative Gamma
Imagine an extremely simplified option market in SPX: there is only one customer and only one Market Maker. When the SPX index price is 5875.00, the customer buys 200 SPX 5700P contracts expiring in a few days. (The timing is not important in this example because we are going to ignore theta and charm influence.)
The contract has the following delta and gamma values:
- Delta = -0.25
- Gamma = 0.01
Since the Market Maker is the seller and there are no other participants in this simplified market, the Market Maker’s net option inventory is short 200 of the SPX 5700Ps that the customer bought. Let’s fully express the Market Maker’s position in terms of delta and gamma:
- Market Maker Net Delta = -1 * -0.25 x 100 x 200 = +5000
- Market Maker Net Gamma = -1 * 0.01 x 100 x 200 = -200
The Market Maker is long 5000 deltas of SPX, which means if the SPX price were to decline by $1, the Market Maker PnL would drop by -$5000, and if the SPX price were to increase by $1, the Market Maker PnL would go up by +$5000. The Market Maker does not want this directional risk, so a delta hedge must be placed.
We know that an E-mini S&P 500 future moves $50 per point, and since the Market Maker needs to protect against $5000 per $1 index move, the Market Maker sells 100 E-mini S&P 500 futures to hedge the initial position. Here’s what the Market Maker’s portfolio looks like now:
- -200 SPX 5700P
- -100 E-mini S&P 500 futures
Let’s work through two scenarios for the SPX next move.
Negative Gamma and SPX decreases by $1
SPX price drops by $1. What happens to the 200 SPX 5700P delta and gamma values in the Market Maker’s inventory?
- Market Maker Net Delta = -1 * -0.26 x 100 x 200 = +5200
- Market Maker Net Gamma = -1 * 0.012 x 100 x 200 = -240
Why did the delta on the contract get more negative (from -0.25 to -0.26)? Gamma is the rate of change of delta per $1 change in the underlying price, and since the gamma magnitude was 0.01 the delta got more negative by 0.01.
The -100 E-mini S&P 500 futures are no longer a sufficient hedge for the Market Maker’s option inventory!
Market Maker Net Delta has increased from +5000 to +5200, a +200 delta increase, which now means that a $1 move in the index will produce a +/- $5200 PnL swing. The Market Maker must sell 4 more E-mini S&P 500 futures to get back to directionally hedged, bringing their portfolio to:
- -200 SPX 5700P
- -104 E-mini S&P 500 futures
Before we move on to the next scenario, let’s take a minute to reflect on what just happened:
- The Market Maker net gamma is negative
- The SPX price went down by $1
- The Market Maker SOLD E-mini S&P 500 futures into this price weakness
The Market Maker’s hedging activity was a trade in the direction of the SPX price move! This is a feature of Market Maker negative net gamma.
Negative Gamma and SPX increases by $1
SPX price rallies by $1. What happens to the 200 SPX 5700P delta and gamma values in the Market Maker’s inventory?
- Market Maker Net Delta = -1 * -0.24 x 100 x 200 = +4800
- Market Maker Net Gamma = -1 * 0.008 x 100 x 200 = -160
In contrast, the -100 E-mini S&P 500 futures are now an “over” hedge for the Market Maker’s option inventory!
The Market Maker buys back 4 E-mini S&P 500 futures to hedge the new net delta, bringing their portfolio to:
- -200 SPX 5700P
- -96 E-mini S&P 500 futures
Let’s reflect on what happened (again):
- The Market Maker net gamma is negative
- The SPX price went up by $1
- The Market Maker BOUGHT E-mini S&P 500 futures into this price strength
Same as the first scenario, the Market Maker’s hedging activity was a trade in the direction of the SPX price move (again)!
When the Market Maker position has negative net gamma, their hedging activity can be described as “throwing fuel on the fire” since they are trading in the direction of the price move.
Delta Hedging: Positive Gamma
Let’s continue with our simplified SPX option market: again, there is only one customer and only one market maker and the SPX index price is 5975.00. This time, though, the customer sells 50 SPX 6050C contracts expiring in a few days. (Again, the timing is not important in this example as we are temporarily ignoring theta and charm influence.)
The contract has the following delta and gamma values:
- Delta = +0.40
- Gamma = 0.02
Since the Market Maker is the buyer and there are no other participants in this simplified market, the Market Maker’s net option inventory is long 200 of the SPX 6050Cs that the customer sold. Let’s fully express the Market Maker’s position in terms of delta and gamma:
- Market Maker Net Delta = 0.40 x 100 x 50 = +2000
- Market Maker Net Gamma = 0.02 x 100 x 50 = +100
The Market Maker is long 2000 deltas of SPX, which means if the SPX price were to decline by $1, the Market Maker PnL would drop by -$2000, and if the SPX price were to increase by $1, the Market Maker PnL would go up by +$2000. Remember, the core assumption of this model is that Market Makers do not want directional risk, so a delta hedge must be placed.
Since the Market Maker needs to protect against $2000 in PnL swing per $1 index move, the Market Maker sells 40 E-mini S&P 500 futures to hedge the initial position. Here’s what the Market Maker’s portfolio looks like now:
- +50 SPX 6050C
- -40 E-mini S&P 500 futures
Let’s work through two scenarios for the SPX next move.
Positive Gamma and SPX decreases by $1
SPX price drops by $1. What happens to the 50 SPX 6050C delta and gamma values in the Market Maker’s inventory?
- Market Maker Net Delta = 0.38 x 100 x 50 = +1900
- Market Maker Net Gamma = 0.018 x 100 x 50 = 90
Why did the delta on the contract decline (from +0.40 to +0.38)? Gamma is the rate of change of delta per $1 change in the underlying price, and since the gamma magnitude was 0.02 the delta went down by 0.02.
Those -40 E-mini S&P 500 futures are now an excessive hedge for the Market Maker’s option inventory!
Market Maker Net Delta has decreased from +2000 to +1900, a -100 delta decline, which now means that a $1 move in the index will produce a +/- $1900 swing. The Market Maker must buy back 2 E-mini S&P 500 futures to get back to directionally hedged, bringing their portfolio to:
- +50 SPX 6050C
- -38 E-mini S&P 500 futures
Before we move on to the next scenario, let’s reflect for a moment on what just happened:
- The Market Maker net gamma is positive
- The SPX price went down by $1
- The Market Maker bought back E-mini S&P 500 futures into this price weakness
The Market Maker’s hedging activity was a trade in the OPPOSITE direction of the SPX price move, which happened to be down. The Market Maker “bought the dip”! This is a feature of Market Maker positive gamma.
Positive Gamma and SPX increases by $1
SPX price rallies by $1. What happens to the 50 SPX 6050C delta and gamma values in the Market Maker’s inventory?
- Market Maker Net Delta = 0.42 x 100 x 50 = +2100
- Market Maker Net Gamma = 0.023 x 100 x 50 = +115
Uh oh, those -40 E-mini S&P 500 futures are no longer a sufficient hedge for the Market Maker’s option inventory!
The Market Maker sells 2 more E-mini S&P 500 futures to accommodate the new, larger delta exposure, bringing their portfolio to:
- +50 SPX 6050C
- -42 E-mini S&P 500 futures
Let’s once again think carefully about what just happened:
- The Market Maker net gamma is positive
- The SPX price went up by $1
- The Market Maker sold more E-mini S&P 500 futures into this price strength
Similar to the other scenario, the Market Maker’s hedging activity was a trade in the OPPOSITE direction of the SPX price move, which happened to be up. The Market Maker “sold the rip”!
When the Market Maker position has positive net gamma, their hedging activity can be described as suppressive, since they will “buy the dip” on price declines and “sell the rip” on price rallies.
Summary
The Periscope SPX Market Maker Exposure page gives you a crystal clear look into the net inventory of Market Maker SPX options, which is of course a reflection of customer positioning in the SPX. The net gamma exposure view shows you, strike-by-strike, the net gamma exposure of Market Makers, which you can use to determine if their delta hedging activity is more likely to accelerate (when the net gamma exposure is negative) price movements or suppress (when the net gamma exposure is positive) price movements.
In our next article (coming soon!), we will walk through a similar treatment of Market Maker net charm exposure. Stay tuned!