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What basic assumptions are made in calculating gamma exposure?

This article is part of a more broad series of research questions I address regarding Gamma Exposure. Check out this post for more.

Note below adapted from SqueezeMetrics White Paper

There are a few assumptions we make when we calculate gamma exposure. These are the following assumptions:

All options traded are facilitated by delta-hedgers. We assume that all orders run through a market maker who owns a book of options.

Call options are sold by investors and bought by market makers. Based off skew, open interest at a strike, and effects of GEX, call overwriting drives the options market for calls. We assume call options are written as covered calls for portfolios.

Put options are sold by investors and bought by market makers. Puts are bought by parties looking to protection their portfolios against a drop in market prices.

Based off skew, the implied volatility of put options is generally higher than the implied volatility for call options.

Market makers hedged deltas continuously. This may not be the case, but the assumption is held for the purposes of gamma exposure.

Possible issues for those assumptions above:

If traders and investors are buying more call options than they are selling to market makers, this would drastically change the calculation of gamma exposure. This would also be true if traders and investors are selling more put options than they are buying from market makers.

Like any signal in the market, the gamma exposure signal could go away as it becomes more known. For that reason, gamma exposure should only be used as one component of your decision making process.


Author: Trader Court

CPA first, pivoted to python programmer focused on data science which I apply to my own stock and options trading.

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