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Guest Post: Does Gamma Fuel Market Moves?
Submitted by Fred Oltarsh at Libanman Futures
Does Gamma Fuel Market Moves?
Each week at Libanman Futures we review the CFTC’s COT Report which we have attached below for the Wheat Market. Many people follow the report as it pertains to various trading groups. The report provides an opportunity to gain insight into the deltas of a particular category of traders. We are most intrigued by the idea of the change in delta by a particular group as it pertains solely to the change in the Groups’ Gamma.
For example, in the latest rally in Wheat, how much of the increase in short deltas by the Net Commercials is due to actual increased short positions through the selling of futures, the selling of calls or the purchase of puts and how much is due to the negative gamma of the positions of the Net Commercials? In the past, there have been many large Commercials who, while trading options, have had significant delta changes due to negative gamma. In some of these cases, the difficulty of managing these large short options positions has caused firms to go out of business. It is an interesting challenge to determine when the Commercials are increasing short positions due to a desire to sell into a rally and when they are getting shorter than they would like due to the negative gamma of their options positions. The chart below, may give some insight to the predicament that certain Commercials are facing in Wheat. The idea is merely speculation, but it does shed some insight into the wonders of negative gamma and short options positions. This type of phenomenon has certainly happened in the past in Cotton, Sugar and Natural Gas to name a few and it always provides for an interesting trading environment.
As the chart below shows, the short deltas of the Net Commercials have risen sharply in the last month. During that period the price of Wheat has increased almost 40%. An interesting question at this point is how much of that short delta change is due to negative gamma as opposed to new selling of futures, calls and purchasing of puts. It is a question worth considering although a definitive answer is unlikely to appear for quite a while. If the Commercials are getting shorter then intended due to the effects of negative gamma and the market continues to rally, there is a potential for significant short covering by the Commercials due to positions that were not originally intended.
Fred Oltarsh is the Senior VP at Libanman Futures Inc, a New York based brokerage firm. Prior to joining Libanman Futures, Fred was an options market-maker on the floor of NYBOT/NYMEX for more than fifteen years and Head of Risk Management at NYBOT/ICE Futures for seven years. His focus involves improving the knowledge and trading skills of the people I work with. I look forward to discussing your trading objectives with you. For more information, please call me at 347-949-4546, email me at fred.oltarsh@libanman.com, or visit http://www.libanman.com/.
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Gamma, bitchez
While I sort of "get" the gist of the article, I'll have to say that trading is now far too complicated. Futures markets distort genuine price discovery.
All hedging distorts price. Too complex. Time to cut back on the arb skims at the high volume penny level.
Simplify. If a farmer has to think like a futures trader, he will never plant the optimum crop density but merely the most financially optimal one.
Food crisis dead ahead.
Unless we go back to "alpha" state!
;-)
ORI
http://aadivaahan.wordpress.com
It has always been this way.
Sorry Ori.
In some shape or form yes, mephisto.
But leverage is a great force multplier and therefore a great distorter.
Distorted systems behave irrationally instead of just unpredictably.
ORI
http://aadivaahan.wordpress.com
Options have been traded for 100's of years. Hegding option positions via binomial or Black/Scholes models have been happening for at least 30 years. So yeah, big positions with large price movements produce rapid gamma (2nd derivative) changes that require chasing or dumping the underlying to stay hedged. Nothing new or that complicated here.
Speaking as a farmer, what is it you think we do in deciding what to plant? Like any *business*, profit drives decisions and looking at which crop is likely to maximize income is obviously always in play. It has to be given the costs involved in farming...
True Close, but the larger the futures market is, the more it distorts the "actual" price, am I right?
Basically "spot" is dead or at last gasp and that is not a good thing, is th epoint I was making.
ORI
http://aadivaahan.wordpress.com
Is Gamma the name of the bankster's bot?
This is a really great point. Here is the latest COT report on the aggregated net futures positions of commercials, showing them actually long wheat, based on futures with zero gamma. The position changes and significant variances with large/retail specs (i.e., value vs. momentum players) seem to have the most predictive value. One thing notable is how commercials seem to be fading the bean rally, but there are many factors that go into these reports, and the commercials can fade a trend for a very long time.
Commodity
12-mo low
12-mo hi
30-Jul
23-Jul
Cattle (feed)
-2,917
5,766
2,844
1,716
Cattle (live)
-68,536
23,656
-36,102
-31,840
Hogs
-38,039
35,452
-6,679
-8,015
Corn
-133,074
119,389
-38,391
-44,446
Oats
-4,608
829
-2,538
-2,366
Soybeans
-88,183
56,797
-52,233
-59,222
Soybean meal
-73,524
-6,350
-73,524
-73,034
Soybean oil
-55,029
32,394
-9,892
1,423
Wheat
17,351
82,654
18,437
23,291
Orange juice
-22,027
-9,100
-11,715
-9,498
Coffee
-46,099
-4,637
-46,099
-44,536
Cocoa
-49,897
-19,889
-25,922
-32,168
Sugar
-249,405
-104,983
-130,306
-118,601
Cotton
-58,803
-12,037
-19,593
-12,970
British pound
-1,717
97,211
28,091
33,697
Canada dollar
-105,107
-26,402
-44,836
-39,057
Euro FX
-75,540
124,494
29,259
33,054
Japanese yen
-66,127
92,866
-30,599
-47,659
Swiss franc
-37,877
27,482
-13,390
-21,006
US dollar index
-46,250
14,351
-15,974
-16,270
Mexican Peso
-118,008
19,803
-49,512
-39,059
Australian dollar
-102,706
-10,793
-49,975
-39,150
S&P 500
-83,827
33,981
21,118
28,791
T-note -10 yr
15,365
356,573
168,055
183,889
T-bond -30 yr
15,149
158,206
24,561
31,690
Eurodollar
-1,020,787
105,872
-646,892
-594,498
Crude oil
-152,994
-21,946
-42,887
-28,747
Heating oil
-69,179
-10,043
-18,050
-17,528
Unleaded gas
-91,597
-26,743
-50,210
-42,759
Natural gas
104,205
179,433
123,978
123,701
Copper
-30,974
8,920
-5,182
742
Gold
-308,231
-204,545
-227,555
-215,664
Platinum
-28,350
-14,990
-18,144
-15,759
Silver
-66,004
-37,800
-46,768
-47,960
Since the curve for gamma is very steep around the strike, can't they buy a large number of OTM options as a hedge?
No, delta is too low for far OTM - practically nothing. If you want to cheaply offest position for a short while you may buy deep ITM or buy a vertical (buy ATM sell OTM to offselt cost)
Thanks. I was thinking if you have some short calls far OTM enough, you can sit on the neg gamma and yield a profit.
There is nothing sinister about short gamma. Farmers, middlemen etc buy insurance in the form of options (not necessarily just futures) to hedge their natural exposure to future prices. Someone has to sell them the options. If you buy a call or a put from someone else, he/she has a short gamma position. Now, in order to underwrite this insurance so that he/she does not have a net preference of where the direction of the commodity goes, the trader has to 'hedge' his position. We have got to stop this luddite attitude that everytime someone talks about 'hedges' or some financial technology term that is not commonly understood, we go into a panic state and think that something nefarious is afoot.
BTW, Gamma is high near strike and if there are sufficient strikes nearby, you can buy options to offset some of that non-linear risk. However, the gamma profile becomes really steep as we near the maturity of the options, and further OTM options becomes less useful to offset this risk.
How the market reacts to this delta hedging depends on the liquidity of the market at the hedge points and how careful the trader is.
Good points. Also, haven't looked at this specifically, but with the way wheat has been moving, skew has no doubt blown out considerably so if you are going to buy options to trade your delta and get back to neutral expect to pay a hefty premium. At this point their only options are to either bite the bullet and buy back those deltas, or continue to lean short and hope that wheat has a dramatic retrace so that they don't have to negative scalp themselves.
some firms went out of business... negative gamma generally implies short vega - think someone trying to sell volatility via straddle/strangle or doing something like backratios http://1.bp.blogspot.com/_OwyMhAykAZ0/SsOotE5vEuI/AAAAAAAAAFw/1AEkK8W5IW... something like that except risk profile is flipped vertically (in the pic they are buying a backratio).
If vol blew up even if the price didn't change, you now suddenly find yourself in a losing position which requires you to put up more capital. Go figure.
Sure, you can do better, sell far OTM strangle.. low delta and more income. The question becomes how good you're at hedging moves.
Nice article. i like reading from an academic/theory standpoint from time to time.
Guest answer: yes.
Tough to know what they're actually doing, but if one were long futures and still bullish, as price rose one should consider buying puts (neg. delta, neg. theta, pos. gamma, pos. vega) on the way up. This would of course create a synthetic long call -- locking in profits, cutting risk, while letting profits run. Once the synthetic call is in place then one can spread off some or all of its cost with neg. gammas. So between selling futures, selling calls, or buying puts, the puts have it.
There are certainly a lot of details like that to take into consideration.I read and understand the entire article and I really enjoyed it to be honest.
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