I see Zero Hedge, talk about extreme negative gamma position of dealers all the time which it then ties back to market moves. I was wondering how do you calculate such market positioning based on publicly available data. Has someone done it or any ideas how to do it?
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This is what flow derivatives desks call the "Gamma Hammer" (in the morning huddle) or "pin risk" (more formally).
In the run-up to quarterly expiry, imagine that the dealers as a group have a net gamma position versus the market (ie their clients), who have to be running the opposite gamma position. Across the market, there is no net gamma position. There cannot be, by definition. But within the market, the difference is that the banks have to hedge their book; while the punters don't.
So:
if the brokers are positive gamma and the market goes up, their delta will become more positive. The brokers have to sell the market. If the brokers are positive gamma and the market goes down, their delta will become more negative. The brokers have to buy the market. Brokers will buy the dip and sell the rally, helping to pin the market down.
and vice versa. on the other side, if the brokers are negative gamma, market moves will create a delta position reversed to the direction of market movement. To hedge that delta, the brokers have to buy the rally and sell the dip, which (potentially) amplifies market movements and volatility.
Dealer flow desks really believe in this stuff. They really do. My only caveats are (1) that most of them also believe in some fairly weird other stuff. And (2) this is a group of people who have run out of greek letters to describe risk, for whom "vega" is a normal concept and "zanda" really exists...
Let's take it as a given this argument is really true. Can you then track it? No, and the dealers themselves can only guess. They can look at the options outstanding for every strike to get a feel for the aggregate gamma risk out there (on listed product). But they cannot know how much is hedged by an investor owning call-spreads, put-spreads etc, or eg selling NASDAQ puts to buy S&P calls etc. And there is a positive and negative side to every gamma risk. The data tells you nothing about the imbalance within the market, in terms of who is long vs short when expiry happens. Nor does it tell you anything about the OTC flow that is never routed to the exchange only reporting its positions.
So it's a finger-in-the-air affair. At the very least, it's a good talking point for one week in 13, which the ZeroHedge crowd also seem to love ;-)
hope this helps
