Dealer Vanna Exposure In Options Expiration Week: Greeks For The Week, July 17-21

Welcome to July options expiration week! This week has an interesting dynamic. July options expire and create a little bit more of a vanna vacuum. However, a lot of the August hedging is already completed, so options expiration doesn’t reduce much.

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 July 17-21

Here’s the aggregate dealer vanna positioning in SPX:

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

It seems robust, but this is $30B of aggregate vanna which is 65% of average vanna levels.

As we learn more about this intriguing greek, we learn the lower aggregate vanna is, the more volatility we experience. Further, we are at a time where IV is lower than recent history. It can always drop more, but I’d wait for a lower historical volatility (HV) reading before I project a lower IV.

Until we see a lower HV reading, there are several possible macroeconomic catalysts that can expand IV and HV pretty quickly. These include the July FOMC meeting, the July BoJ meeting, large cap earnings, labor disputes, and swiftly deteriorating deflation and employment data.

As a result, we are walking a tightrope of bullishness successfully for now, and I project the only thing that can cause significant downside this week is the vanna drop from options expiration. But this is not a significant catalyst, and would only show as modest downside late this week and next.

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