I don't think that is the right way to think about it. Delta vs Gamma hedging.
Delta hedging is when you open a cash position in the proportion to the delta of the option that you sold. As a rough rule of thumb, delta is ~0.5 at the money. So say you buy 100 at the money SPY call contracts. That maps to 10k actual SPY positions. The dealer sells you the options and he buys 5k actual SPY. As the index moves, the dealer will proportionately buys/sells the SPY position to match the delta.
This is all fine if the market is moving smoothly. But changes in delta are not linear. If the market makes a big move, delta hedging won't help you. To protect against sudden big moves, the dealer does gamma hedging. Gamma refers to the rate of change of an option's delta with respect to the change in price of the underlying asset. Essentially, gamma is the rate of change of the price of an option.
Now if you hedge your position to oblivion, you will have no profits. So everyone stops somewhere. When you look at the gamma surface yesterday, you see that there was point where the gamma hedges had stopped. That's the part where the surface slope sharply dropped. In a thin market, the underlying can be jerky. When the index fell over the line, the dealers had no protection and had to sell sharply to protect themselves on the puts they had sold which were now going into money. That selling fed on itself.
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There are two key takeaways here - at least for me, and I don't claim to be an options guru - the first is that unlike what many claim, the options do not *control* the index. But they dictate what the market makers have to do should the index move against them. The 2nd takeaway is that if there are air pockets in the surface, then once the market crosses the line, it will take a life of its own until the index reaches the bottom of the slope.
If someone has real time access to the market flow and derivatives flow, then can certainly make good money off of this knowledge. BUT, that someone would have to be Citadel or a similar entity. The regular people, or even 90% of the hedge funds, do not have access to that kind of data. They can make educated guesses about it, but they cannot navigate it swiftly and decisively. This is why I don't believe in a "they". |
