Gamma ‘Close To The Cliff’, Raising Risk Of ‘Asymmetric Move Higher In Volatility’

On Tuesday, as stocks careened lower on what unnamed officials would later describe as “off the cuff remarks” from Donald Trump who seemed to cast doubt on the prospects for an interim trade agreement with China that averts further escalations, Nomura’s Charlie McElligott noted that the gamma “flip zone” was near.

“Looking at SPX options, we see the Dealer $Gamma position nearing the potential ‘flip’ level to ‘SHORT GAMMA’ ~ 3073, which would of course beget more selling [to] hedge the lower futures travel”, he wrote.

Minutes later, he sent out an updated version of a chart that shows the relationship between gamma and intraday ranges for equities. Charlie included his customary multi-colored headlines so there’s no ambiguity:

(Nomura)

This underscores something SocGen pointed out in September, when the bank noted that “price movements over [the] summer once again clearly emphasized the spot/gamma/realized vol dynamics”.

They continued: “All the big daily moves (magnitudes larger than 1.5%) occurred when the previous day’s aggregate gamma estimate was negative”.

Last month, gamma was consistently positive, which helped to “pin” spot and perpetuate what McElligott described as a “range-y” grind to new highs, but which looked, to market participants anyway, like an almost inexplicable calm.

Well, SocGen is out concurring with McElligott’s Tuesday note, and they offer a series of helpful visuals along the way.

“S&P 500 spot is once again close to our estimate of the gamma-transition-level (below which aggregate dealer gamma from listed options turns negative)”, the bank’s Jitesh Kumar, Vincent Cassot and Gaurav Tiwari wrote, in a Wednesday note, adding that “such a transition is generally followed by an asymmetrically volatile period”.

(SocGen)

The bank goes on to underscore what was behind the “unheard of” calm in November. “The monthly volatility on the S&P500 index was the fourth lowest in the last 600 months (50 years) which was a far cry from Q4 last year”, SocGen writes, on the way to noting that it was no coincidence. “We believe this low level of volatility is consistent with the extremely large level of positive gamma seen in the S&P500 options space”.

Indeed, the average for last month was the largest ever on the bank’s model (left pane).

(SocGen)

Not only that, the distance from the “flip” level was the third largest ever, “suggesting that the spot level has been maintaining a very safe distance from the transition boundary”, the bank notes (right pane above).

So, there you go – more color on one of the most popular topics among our readers.

The last two days have seen spot move back up materially thanks to a lack of balderdash from Donald Trump, and as SocGen reminds you, “a move higher in spot could lead to higher gamma levels and therefore lower volatility”.

But the overall thrust here, is that we’re edging closer to the “cliff”, so a sharp move lower could cause stocks to escape from the gravitational field. If that ends up pushing spot through levels associated with trend de-leveraging, things could become altogether untethered.

Read more: Nomura’s McElligott Warns: ‘We’re Nearing Gamma Flip Risk In SPX’