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Why does gamma exposure suppress or exacerbate stock price movements?

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

When gamma exposure is positive, it implies that market makers will hedge their positions in a manner that stifles volatility. It means market makers are selling into  highs and buying into lows. They are essentially buying the dip and selling the rip, and keeping volatility low in the process.

When gamma exposure is negative, it implies market makers will hedge their trades in a manner that magnifies the movement of the market. Market makers are now selling into the lows or buying into the highs.

Market makers are buying or selling their stock positions in the same direction with the current market. This is one reason why selloffs can become so deep, and why the swing back after a market selloff is so dramatic.

Much of this has to do with the effect of gamma and how it affects the delta of an options position. The gamma is a measure of the effect a $1 move on the underlying stock will have on delta.

If a market maker has a large gamma exposure value in their option book, then a $1 move in the underlying has a large effect on the delta exposure of a dealers book. This means when gamma is high, you can anticipate large changes in the delta, which the dealer will ultimately hedge against.


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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