Gamma Flip: A Primer

Gamma season is always in.

But when is gamma season bullish or bearish?

Let's talk about the gamma flip, and what that means for the markets, along with individual stocks. But first, we need to talk about an assumption of gamma exposure.

It is assumed, that MM's are always long calls and short puts in a positive gamma market. This means that investors are selling OTM calls and buying OTM puts. For hedging purposes, the MM needs to short shares to adjust to their positive delta, and remain delta neutral.

Is this accurate? Most likely not, MM's provide liquidity everywhere. However, for modeling basic gamma exposure, you need to make this assumption. The reasoning for this assumption is that markets typically always go up (bull markets > bear markets). Does this matter in the short term? Also no, since things can change very quickly, especially in this new options climate. But, it's an assumption, none-the-less.

More on the assumption:
Investors/retail in a bull market will be long shares, and sell covered OTM calls to increase passive income, but will long OTM puts for downside protection. This goes back to MM's thought of as being long calls and short puts, buying shares on the way down, and selling on the way up. In this time, gamma is positive overall.

Now for the gamma flip.

The gamma flip happens when gamma exposure goes from positive to negative, at least by underlying principles described above. This causes MM's to reverse their hedging strategy. I have some further thoughts on gamma flips, but that's outside the scope of this thread.

Anyhow, the reversed hedging strategy means MM's need to sell shares on the way down, and buy shares on the way up. This leads to extreme movements in either direction, and a period of heightened volatility until gamma exposure turns positive again.

Since the gamma flip is around a point where a stock would be regressing and in a downtrend, the flip to negative gamma accelerates the downward movement of a stock, causing a flash crash and, as stated, more volatility.

The system will stabilize itself due to the markets being inherently mean reverting, or at least to a point where MM's can rebalance their positions and adjust exposure. You can somewhat see how this translates across the S&P with the VIX here.

Image

Gamma exp. turning negative causes a spike within the VIX, which is where we'd see that heightened volatility, and flash crashing of SPX.

This applies to individual stocks too, but the effects are far harder to measure since there isn't a volatility index for each stock.

The TL;DR

When net gamma exposure turns negative, things are at least temporarily bearish until the trend stabilizes. Gamma exposure flipping from positive to negative is what the gamma flip is. Negative gamma exposure, however, means that it's /usually/ close to a time where reversals happen, and stocks in this area should be put on a watchlist for going long in the future. Hope y'all learned something here.

As always, if you have any questions or comments, my DM's are always open on twitter @falcon_fintwit

Thanks for reading :)