Dealer Vanna Exposure In Options Expiration Week: Greeks For The Week, August 14-18

Welcome to August options expiration week! 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 August 14-18

In August opex, we notice a lot of vanna at the 4400 strike in SPX.

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

That means that if the market finds its way past 4400, all that positive vanna (and negative charm) flips to a more bearish force.

This is the vanna excluding the August expiration:

Image: SPX, vanna, September and later expirations. https://www.vol.land

4300 becomes the big strike to cross.

Furthermore, the customer-sold call vanna that was so pivotal over the past couple of months has dissipated from price movement and natural vol decline.

Over the next week, if 4400 SPX is crossed to the downside impulsively, dealers must flip from net buyers to net sellers – but 4400 will likely become a pin. It would take some strong outside forces to push the price down past that level, with enough force to cause major dealer selling. We have not seen a lot of re-hedging into September opex yet, but it seems like 4300 is a focal point for hedging. For this week, 4400 is the price to watch.

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