Options Dealer Vanna Exposure And Event Impacts: Greeks For The Week, June 12-16, With CPI, FOMC, ECB, And BoJ

Using the individually categorized methods available in the Volland dashboard, let’s review option dealer positioning to analyze dealers’ hedging behavior on the S&P 500 Index (^SPX).

What Is Vanna?

The option greek vanna is the sensitivity of deltas (how much profit you can expect with a $1 increase in the underlying stock price) to changes in implied volatility (IV). It can also be interpreted as changes to vega, based on movements in the underlying.

To be more precise, vanna measures the change in deltas for every 1-point change in annualized IV on that particular option (fixed price volatility).

Dealer vanna positioning is inversely correlated to market trend. In other words, if total dealer notional vanna is positive, the market trend will be negative as long as IV is increasing, and vice versa. On an individual strike basis, positive vanna will act as a magnet while negative vanna will act as a repellent assuming IV is acting in accordance with its spot-vol correlation.

Who Are Option Dealers?

When an option order is received, a middle man, called an “options dealer”, “options market maker”, or “options wholesaler”, is financially incentivized to accept the order. These entities provide essential liquidity for markets to function. Because they are exposed to adverse selection, they are motivated to hedge their risk.

Nowadays, there are only a few wholesaling companies. Currently, most market making is done through algorithms and computers, and there is very little physical trading at an exchange. It is estimated by the Chicago Board of Options Exchange that 85-90% of all option orders are accepted by option dealers.

A Look At June 12-16

Last week showed a modest rally upon a large drop in IV and the CBOE Volatility Index (^VIX). With such high positive vanna in SPX, that means that dealers were buying heavily but were offset by other players. Further, hedging started to take hold in the form of sold calls instead of bought puts.

Image: SPX vanna, all expirations. www.vol.land.

After the June options expiration, we could see a drop in positive vanna. Therefore, an expansion of IV can mean a drop in markets.

This week, however, is an event-loaded week, with the Consumer Price Index (CPI) release on Tuesday, the Federal Open Market Committee (FOMC) decision and press conference on Wednesday, the European Central Bank (ECB) interest rate decision on Thursday, and the Bank of Japan (BoJ) interest rate decision on Thursday evening.

With all these events, I would expect IV to be substantially higher over the next week than the weeks afterward. This higher IV is called “event volatility”, which is volatility specifically priced for the events. Typically, if the events are not too far from market projections, event volatility will push markets to the upside in positive vanna environments. However, with the drop in IV over the past week, any deviation from expectations could cause outsized moves to the upside or downside. Because of the strong positive vanna, the lean is to the upside. As a result, I would exercise caution trading the events this week.

Though there are many others who have an idea of how the FOMC, ECB, and BoJ would act, the option dealer positioning is saying to cautiously lean to the upside this week but to be hedged in case of downside. Either way, we could see strong moves in markets from the events this week.

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