Dealer Hedging Dynamics - Risk Profiles
About this lesson
It's important to grasp the mechanics of the delta behavior in order to be able to think correctly on the fly when incorporating dealer hedging dynamics (GEX, Charm, Vanna) into your trading decisions.
These forces can be powerful- especially during low volume or low liquidity periods.
Practice drilling these basics-
When I refer to market impact I'm getting to the heart of what matters about this process.
The market impact of a dealer's long call option position when time passes is UP
The market impact of a dealer's short put option position when time passes is UP
Can you explain why?
If not, then drill the:
dynamic hedging flow's impact on the market
For each of these three Greeks:
- Gamma
- Charm
- Vanna
and for each of these three Option types:
- 20 Delta Call (or -80 Delta Put)
- 50 Delta Call (or -50 Delta Put)
- -20 Delta Put (or 80 Delta Call)
You'll get quick reference guide showing exactly this for each possibility- from it, construct and map out your own sequences- or "paths"- to hypothesize what happens when combinations of *changes* happen through time-
It may seem boring. It may seem frustrating. But drilling these fundamentals over and over will create a framework in your head which will become so intuitive- you'll be able to quickly glance at an OptionsDepth profile & know exactly what position the dealers are holding as well as what basic market response to expect in all the imaginable outcomes.
Nothing happening? Great! You'll know to expect the market to drift lower if dealers are long downside gamma!
Vol exploding? Great! You'll know that the rally is forced higher because dealers were short calls!
Seem trivial? Well it's not- because when you understand these interactions, you are well equipped to spot them in real time. Take that second hypothetical, for example- if higher implied volatility helped force the market higher- then as soon as you see evidence of volatility retreating you lean into the reversal.
Opportunities like these happen all the time 🎯