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Dealer gamma positioning

Whether options dealers are net long or short gamma, which determines if their hedging suppresses volatility or amplifies it.

When dealers are net long gamma they hedge by selling rallies and buying dips, which mutes movement and produces the slow grinding tape traders complain about. When they are net short gamma they must buy strength and sell weakness, and moves feed on themselves.

The positioning flips around large strikes and around opex, which is why market character can change abruptly on the Monday after expiration. The concept is sound; the published estimates of it are inferences built on assumptions about who holds what.

Example: with heavy customer call buying in XYZ, dealers are short those calls and short gamma. XYZ ticks up through $50 and they must buy shares to stay hedged, which pushes it higher, which forces more buying — the mechanism behind a gamma-squeeze.

Related: gamma-exposure, gamma-squeeze, delta-hedging, opex-effects

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Bollinger bands squeezing and then expandingA price line between three curves: an average in the middle and a band above and below it that pinch together in the centre of the chart and then spread apart as the price runs higher.PRICE WITH BOLLINGER BANDS (20, 2)SQUEEZEupper bandpricemiddle band20-day averagelower bandbands widen asvolatility risesIllustrative prices. The bands sit two standard deviations from the average.
Bollinger bands: squeeze and expansion. The middle line is a 20-day average and the outer bands sit a set number of standard deviations away, so they measure how far price has recently been straying. When moves are small the bands pinch together; when moves grow they spread apart.

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