Gamma Flip Suggests Stock Serenity. For Now

Things have calmed down. For now.

In a year defined by uncertainty and cross-asset turmoil, the past several days felt comparatively serene.

Since a cooler-than-expected CPI print triggered a boisterous rally on November 10, US equities closed +/- 1% on just one occasion (Tuesday). More to the point, the range has compressed meaningfully (figure below).

The pale blue annotations in the visual mark the 194-point intraday reversal witnessed last month following September’s CPI print, and the fireworks around Jerome Powell’s press conference on November 2.

I suppose you could cite a pre-Thanksgiving lull for the range compression (green arrow), but I don’t think that’s particularly interesting. More compelling is a stabilization in dealer positioning, which is (or at least was before the holiday) long or neutral gamma across US equities.

Nomura’s Charlie McElligott cited the rally in spot and a “dramatic increase in overwriter / underwriter / vol-selling flows.” “You’re seeing that play out in recently smaller intraday trading ranges, generally compressed realized and implied vol and vol of vol pushing back near cycle lows,” he said.


The figure (above), is a reminder of why dealer gamma positioning matters. The scatterplot shows one-day forward returns for US equities and VIX levels by gamma regime.

“Long gamma compresses index vol, while short gamma feeds its expansion,” McElligott wrote.

Positive gamma regimes are typically characterized by a kind of synthetic dip-buying and rip-selling, as hedging flows work to insulate spot from large swings. Negative gamma regimes, by contrast, are conducive to so-called “accelerant” flows, as hedging tends to manifest in outsized directional moves as rallies are bought and selling begets more selling.


The figure (above) shows how the insulation offered by positive gamma regimes can lead to prolonged, “escalator” rallies while negative gamma regimes often exhibit “elevator” selloffs.

“As is [usually] the case in the ‘new’ market structure and post-GFC world [where] de facto ‘negative convexity’ strategies buy strength [and] sell weakness due to risk management [frameworks] where volatility is your exposure toggle, we see second-order mechanical flows again having an outsized impact into already thin year-end liquidity, as many performance-challenged discretionary / fundamental investors are playing a reduced role in current market participation,” McElligott went on to say.

Of course, the calmer the market (i.e., the more contained the daily distribution), the more leverage gets deployed, in true “stability breeds instability” fashion, as mechanical re-risking (e.g., from vol control and CTAs) acts as accumulated snowfall awaiting a shrill skier’s scream.

McElligott summed it up. “Ultimately, this building ‘stability’ can and will breed instability, as excess surge in $Delta and / or unemotional and uneconomical mechanical positioning becomes crowded and can then pose asymmetrical risk of tipping over into fresh macro catalysts,” he said. “But we’re not there yet.”


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3 thoughts on “Gamma Flip Suggests Stock Serenity. For Now

  1. Prof Lucky – I went to B-school after a stint in the real world. We studied those semi-new fangled things called options in a second year class I took in 1981.

    That served me well when I went down to Wall Street. It was surprising how few people there had even an inkling how they worked. Even with warrants and convertible bonds having been around for a while. Gave me a leg up though I cannot boast of my meager level of understanding of the instrument at the time.

    Despite that, over the next ten years I gained some decent experience on the market-maker/book runner side.

    But truth be told, I’ve learned a lot more trading some puts in my PA during the last year. That would be hard to teach.

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