Dealer Vanna And Gamma Exposure In Options Expiration Week: Greeks For The Week, September 11-15

Welcome to September 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.

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.

What is Gamma?

The option greek gamma is the sensitivity of delta to movements in the underlying price.

Dealer gamma positioning is inversely correlated to standard deviations of realized volatility. In other words, as dealer gamma exposure decreases, volatility increases. It is helpful to know this data on a strike-by-strike basis to know how the market will act as it approaches each strike.

The higher magnitude of gamma at each strike, the more that strike can act as an accelerant or support/resistance to the underlying market. A large positive gamma bar would act as support or resistance while large negative gamma bars would act as accelerant.

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 September 11-15

It should be an active week; let’s dive right in. First, here’s the overall vanna picture:

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

There is $14B of total positive vanna below the current price, but $1B above. How much of that vanna is for this week?

Image: SPX, vanna, September 11-15 expirations. https://www.vol.land

We are very close to balanced. At this time, dealers would prefer if the market didn’t move. However, with CPI and Opex this week, movement is likely. How will dealers deal with it?

Unfortunately, with time running short, this vanna formation looks to create severe whipsaw in market price action – with momentum pushing strongly in both directions. Further, the week’s gamma profile is dramatically negative, reinforcing that sentiment.

Image: SPX, gamma, expirations September 11-15. https://www.vol.land

On balance, I think we will whip to the upside – at least initially. This is because the higher order vanna picture supports a reduction in IV, and the macro catalyst event vol is supportive of that IV reduction. However, it can just as swiftly fall as it can rise, so be nimble. A straddle or strangle for this week would be two choices if you wish to make an option trade.

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