Thread by @TradingFloorWs

1/ A lot of people are curious about what Goldman meant by this. Let me break it down for you.

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https://twitter.com/SamanthaLaDuc/status/1665704034777329665

2/ Most investors are naturally bullish on stocks, so they buy put options on the SPX to protect against a market downturn. To finance these puts, they often sell call options. Both of these positions are bearish in nature.

3/ The market makers they trade against, on the other hand, have bullish positions or positive delta (positions that benefit from price increases).

4/ However, market makers don't want directional risk, so they buy and sell the underlying asset to maintain a non-directional position on the price (delta neutral).

5/ As the market moves up and approaches the dealer's long calls, their bullish exposure (positive delta) increases. To hedge their directional risk, they sell futures (negative delta).

6/ When the market falls, the dealer's positive delta decreases. To maintain balance, they buy back some of the hedges. This is known as positive gamma.

7/ In positive gamma territory, dealers sell high and buy low. This provides liquidity to the market and often leads to lower intraday volatility.

8/ However, when the market moves lower beyond a certain point, the hedging dynamics change. Now, as the market goes down, the dealer's bullish exposure increases, so they sell more futures into weakness (negative deltas).

9/ As the market moves higher, their option deltas decrease, so they buy back some futures. This is called negative gamma.

10/ Negative gamma removes liquidity from the market, often causing increased intraday volatility. Mostly associated with a sharp downturn in price.

11/ Historically, hedging flows on indices have typically followed this pattern. But Goldman points out a rare phenomenon.

12/ Investors' panic buying of out-of-the-money call options (above the price) to benefit from a squeeze higher has altered the Gamma profile. If the SPX goes up 4%, instead of becoming longer, dealers start to become short of the market (negative deltas). And this is rare.

13/ Now, instead of selling into strength and reducing volatility, dealers could be compelled to buy high and sell low, removing liquidity from the market and creating heightened intraday volatility as we go higher.

#Investing #MarketVolatility #GammaProfile