giorsims
Short

Options: The Market Amplifiers

INDEX:SPX   S&P 500 Index
34 0 0
Info: http://www.bloomberg.com/news/articles/2016-01-08/that-giant-sucking-sound-you-hear-is-the-etf-options-market

Option pricing models built on the basis of its non-linear payoff, in which you would have delta and gamma exposures. Long an option is long gamma and short theta, with gamma is the "amplifier effect". While option-holders only knows about the premiums, on the background of it, there's a market maker who have to hedge those deltas, as well as gamma (or incremental gamma) eventually, in order the get theta profit (short gamma and long theta).

One thing that is interesting is if the market volume moves from put to call, market maker indeed needs to hedge the risks, thus passing the order from sell-to-buy and vice versa from call to put, especially if it's very large from one point to the other.

Ideally, stock and option should be more a one-way street, since stock is the option underlying. But with such hedging done in the derivatives market that at least wants to be delta-neutral, there can be two-ways relationship. Not only that, as there is gamma, the delta profile of an option grows larger as the option goes further in-to-the-money. And while it started as a hedging product, it is more treated as leveraged product.

The way I see it, of course the steam should start from stock's momentum . But looking at the possibility that for the last one week there has been bull runs that was quite high along with a change of call/put ratio from around 1.2 to 0.6, then it's quite lost its steam when went back to 1.2. As if, when the stock market lost its steam and the option market starts betting, that actually what gives the market "false" buy/sell signals, as it is not logical anymore to hold stock with such high price/earning ratio as what we are seeing in the market now, even if it is earning season. But since now is the age of algorithmic trading, a buy signal is a buy signal, no matter what is the economic and market fundamentals. This is the only logical explanation of what has happened, aside from people simply hungry for yield and buy what they can buy.

It's going to be a hard drop in late April, early May (sell in May, they said). On the magnitude, if it's not like in January, at least in February.

Good luck.
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