Article Gamma and its Importance to the FX Trader

[T2W Bot]

What is gamma?
An option?s price changes with fluctuations in several factors such as spot price, volatility, interest rates and time.  Delta is a measure of the change in option premium with respect to a change in the underlying, or spot, price.  Gamma represents the change in delta for a given change in the spot rate.
In trading terms, players become long gamma when they buy standard puts or calls, and short gamma when they sell them.  When commentators speak of the entire market being long or short gamma, they usually are referring to market-makers in the interbank market.
How market makers view gamma
Let?s consider how market makers view gamma. Generally, options market makers seek to be delta-neutral?that is, they want to hedge their portfolios against movement in the underlying spot rate.  The amount by which their delta, or hedge ratio, changes is known as gamma.
Say a trader is long gamma, meaning that she has bought some standard vanilla options. Assume they...

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[Rhody Trader]

This article discusses how understanding the impact of gamma on the markets can help one know how they will likely trade.

 

[trendie]

Interesting article.
Where does one get/calculate this gamma, then ? Is it similar to "Open Interest" ?
Can it be inferred from other data ?

 

[quentin123]

One, regular spot traders dont know the gamma from the chart - u need to have the option information mapped out to the chart like a field landmine chart - which I doubt anybody has unless u're inventorizing your positions as a bank or a large broker. Two, u cant act on information that u dont have. Three, u know the range AFTER it has formed. Therefore this is certainly not helping much for 'regular spot traders'. I dont know why people still believe in these things.

 

[rog1111]

I have done some similar research in the past (1999) for many commodities, as part of an effort to improve upon the standard call/put ratio. After all what use knowing how many calls & puts there are unless you know WHERE they are. Since most options are written by pros, who will also be very active in the underlying, you can begin to see the logic in it.

Even today, and certainly not back then, I don't think that the options open positions in currencies are substantial enough to have a large bearing on their price, you can partly confirm this by comparison of the weekly futures only COT reports vs futures & options combined, although these will not be the only currency options out there.

IMO there are other commodities for which this is well worth a look, if you can get the data, anything with decent options OI, and a good ratio of options : futures volume

rog1111

 

[rog1111]

GJ thanks for the reply, I accept your comments, and anything is possible, but I doubt whether theres anyone here that can confirm how many otc options are out there ? All good interesting stuff.

regards
rog1111

Rog - what you've written is a little inaccurate. The volume of otc options out there absolutely dwarfs that of exchange traded ones, by several orders of magnitude. That's why this stuff has a real bearing on the activity of the cash spot market. Just because it isn't quantifiable, doesn't mean it doesn't have an effect.

And that's what this article was trying to get at - all you can have is a general understanding of the way it works, and add that to your arsenal of knowledge about the market in which you are trading. Just like knowing that fixing trades have an effect, but not being able to guarantee that they will affect a certain currency in a certain way on a given day.

GJ

 

[wasp]

interesting stuff, brings a whole new light into things

 

[alexander]

The two conclusions of the article are:

Market-makers long gamma: Spot generally will trade in a tighter range
Market-makers short gamma: Spot can be prone to wide swings


But these cannot be general rules or conclusions. The FX market is not affected only by the net position of option market makers. It is also affected (mainly) by macroeconomic fundamentals. It is not unusual to have market-makers long gamma (an expression I would no use by the way because traders are long/short underline assets, not some mathematical measure of those assets) and meanwhile have wild swings or trends or both in underline exchange pairs due to either significant commercial money flow or surprising news or maybe both

Then, the article does not consider how strike prices (in or out-of-the money) of market maker positions affect those conclusions. Generally speaking, those conclusions should be correct only under specific conditions, but limited in nature, like for instance when there are no news to affect market prices and market makers option strike prices are in-the-money, otherwise things get much more complicated and not as easy as the articles portrays them to be. Remember , market makers must take some risk to make more money and always do, hence and examples of firms that have lost a lot of money in FX trading.

I mean, it boils down to this: even if you know whether market makers are long or short gamma can you arbitrage based on this knowledge. Absolutely not. This knowledge is useless as far as making a sure profit.

Alex

 

[wasp]

It may be of little importance for the average retailer when it comes to making trading decisions but for me, understanding your market of choice like your own child, is vital and understanding the effect of options players is another part of the jigsaw and thus, helps to understand the market behaviour as a whole.

 

[jacinto]

mmm, well cool, but where can i know if the market makers are long or short gamma on FX? otherwise it is just theoretical knowledge that is nice to have.

 

[alexander]

mmm, well cool, but where can i know if the market makers are long or short gamma on FX? otherwise it is just theoretical knowledge that is nice to have.

Good point! You will never know that. That is information good for theoretical MBA courses but in practice impossible to get.

Alex

 

[Human Pirana]

As a retail FX trader, one will never really know whats going on in the interbank spot or option markets...

However...

it IS possible to find information about Exchange traded FX options. Assuming that there are at least some Bank desks using these instruments, and assuming that the IB desks know whats going on, can the retail trader "extrapolate" this info onto the OTC FX option market?

I mean the Exchange traded option info is available, so there must be some use for it, right? If only to help guage (?) the sentiment of the OTC market?

Oliver

 

[Human Pirana]

aaahh well...

it seems funny to me that with the dissemination of information that the internet allows, I am still making (albeit paper) trades on such original insight as "when the yellow line touches the blue line, and the pink line isnt near the green one".

Surely there's a better way...

Thank you GJ for your help and prompt response - on both counts.

Oliver

 

[City of Steel]

Would love to hear more on this topic

 

[FxOWL53]

Where is the info....

I am very interested in the concepts of this article. Where do you find the information relating to the Market Maker's gamma position? I have searched the internet for several hours and can find no place that gives that particular piece of information. TY R

 

[FxOWL53]

After reading all the posts to this article it appears that considering market-maker's gamma position is at best an intellectual prsuit with no practical knowledge. Perhaps someone out there with experience trading options knows a way to extrapolate usable info using open interest or the rise and fall of IV, or ???