Practical knowledge about options
- 02/11/2021 – very in-depth study of NOPE, powerful for gamma squeeze or reversed gamma squeeze. “Delta-gamma hedging: The process Mr. MM uses to stay neutral when selling you…OTM options, by buying/selling shares.” “NOPE is a rough and dirty way to approximate the impact of delta-gamma hedging as a function of share volume,” – Dr. Burry likes this, so should I. – I might can use short term OTM to play for upcoming stimulus plan, infrastructure plan, economic opening, interest rate jumps, etc.
NOPE is a funny backronym from Net Options Pricing Effect, which in its most basic sense, measures the impact option delta has on the underlying price, as compared to share price. When I first started investigating NOPE, I called it OPE (options pricing effect), but NOPE sounds funnier.
Effectively, NOPE is a rough and dirty way to approximate the impact of delta-gamma hedging as a function of share volume, with us hand-waving the following factors:
- To keep calculations simple, we assume that all counter-parties are hedged. This is obviously not true, especially for idiots who believe theta ganging is safe, but holds largely true especially for highly liquid tickers, or tickers will designated market makers (e.g. any ticker in the NASDAQ, for instance).
- We assume that all hedging takes place via shares. For SPY and other products tracking the S&P, for instance, market makers can actually hedge via futures or other options. This has the benefit for large positions of not moving the underlying price, but still makes up a fairly small amount of hedges compared to shares.
Winding and Unwinding
I briefly touched on this in a past post, but two properties of NOPE seem to apply well to ER/ER-like behavior (aka any binary catalyst event):
- NOPE measures sentiment — In general, the options market is seen as better informed than share traders (e.g. insiders trade via options, because of leverage + easier to mask positions). Therefore, a heavy call/put skew is usually seen as a bullish sign, while the reverse is also true.
- NOPE measures system stability
I’m not going to one-sentence explain #2, because why say in one sentence what I can write 1000 words on. In short, NOPE intends to measure sensitivity of the system (the ticker) to disruption. This makes sense, when you view it in the context of delta-gamma hedging. When we assume all counter-parties are hedged, this means an absolutely massive amount of shares get sold/purchased when the underlying price moves. This is because of the following:
a) Assume I, Mr. MM sell 1000 call options for NKLA 25C 10/23 and 300 put options for NKLA 15p 10/23. I’m just going to make up deltas because it’s too much effort to calculate them — 30 delta call, 20 delta put.
This implies Mr. MM needs the following to delta hedge: (1000 call options * 30 shares to buy for each) [to balance out writing calls) — (300 put options * 20 shares to sell for each) = 24,000 net shares Mr. MM needs to acquire to balance out his deltas/be fully neutral.
b) This works well when NKLA is at $20. But what about when it hits $19 (because it only can go down, just like their trucks). Thanks to gamma, now we have to recompute the deltas, because they’ve changed for both the calls (they went down) and for the puts (they went up).
Let’s say to keep it simple that now my calls are 20 delta, and my puts are 30 delta. From the 24,000 net shares, Mr. MM has to now have:
(1000 call options * 20 shares to have for each) — (300 put options * 30 shares to sell for each) = 11,000 shares.
Therefore, with a $1 shift in price, now to hedge and be indifferent to direction, Mr. MM has to go from 24,000 shares to 11,000 shares, meaning he has to sell 13,000 shares ASAP, or take on increased risk. Now, you might be saying, “13,000 shares seems small. How would this disrupt the system?”
(This process, by the way, is called hedge unwinding)
My advice so far if you do play ER with the NOPE method is to use it as following:
- Buy/short shares approximately right when the market closes before ER. Ideally even buying it right before the earnings report drops in the AH session is not a bad idea if you can.
- Sell/buy to close said shares at the first sign of major weakness (e.g. if the NOPE predicted outcome is incorrect).
- Sell/buy to close shares even if it is correct ideally before conference call, or by the end of the after-market/pre-market session.
- Only play tickers with high NOPE as well as high option/share vol.
It won’t, in this example. But across thousands of MMs and millions of contracts, this can — especially in highly optioned tickers — make up a substantial fraction of the net flow of shares per day. And as we know from our desk example, the buying or selling of shares directly changes the price of the stock itself.
- 02/11/2021 – Very interesting reading on reverse Gamma Squeeze: “Last year’s tech rally was fueled in large part by a gamma squeeze spurred by call buying in names like Netflix Inc. and Apple Inc. In a world of soaring megacap valuations, the thinking goes that the same forces could be unleashed in the opposite direction with derivatives betting against such names. “Where a put-option gamma squeeze becomes much more dangerous is in mega cap tech names that comprise the indices,” according to Garrett DeSimone, head quant at OptionMetrics, a data provider. “These are much more liquid stocks and have the ability to impact the broader indices and ETFs.” According to Credence Capital Management trader Yannis Couletsis, that kind of liquidity would be the very thing to save the situation. He reckons even if a negative gamma squeeze occurs, real-money buyers are likely to step in and that will ensure the fallout is short-lived. “I would not expect it will provide dramatically meaningful fuel to the fire except for the first couple of days,” the volatility trader said.” – Is this the reason why Dr Burry is quite interesting in the large volume of Put options on TSLA?
Reddit’s Power to Push Stocks Down Is the Next Worry for Traders
(Bloomberg) — The dust may be settling on the Reddit madness, but the sudden rise of this disruptive cohort is causing some stock-options traders to ask: What if the retail army decide to do it all again, by forcing prices down instead of up?
It’s a tail risk few institutional pros had considered until last week’s market drama when day traders pounded hedge funds by bidding up their most-shorted stocks.
While they were igniting a now-famous 400% surge in GameStop, the cohort also loaded up on call options. That forced dealers to buy the underlying equities to hedge their own exposure, pouring fuel on the rally in stocks loved by the Reddit crowd and hated by Wall Street.
Now, some options experts say the message-board masses could exploit this so-called gamma squeeze in reverse, by weaponizing puts to power a sell-off. While the Reddit crowd overall prefer bullish bets for now, plenty of bearish positions were being placed on GameStop as it plummeted back to Earth.
With retail crowd setting their sights on silver and biotech companies this week, traders can be forgiven for fretting what’s next for a crowd seeking to exploit wrinkles in the relationship between stocks and options.
“Put buying en masse would add to dealers’ short put positioning and could create much more severe structural leverage imbalance to the downside,” said Cem Karsan, founder of Aegea Capital Management LLC and a former options market maker.
Karsan, who has 24,000 Twitter followers, floated the scenario on The Derivative podcast last week.
The Squeeze
Once an obscure dynamic in the market plumbing, gamma squeezes are the talk of both Wall Street and the amateur crowd following the GameStop drama.
It goes like this. When an investor buys a call, the dealer who sold the contract will typically hedge by purchasing the underlying stock. The more the latter rises toward the option’s strike price, the more shares the market maker will theoretically have to buy. That can supercharge stock prices as shares rise and dealers buy more.
And the dynamic works in reverse, too.
Dealers who have sold puts will hedge themselves by selling the underlying shares. As the price drops toward the option’s strike, they will sell more and more.
A post on r/WallStreetBets Tuesday described this very market quirk.
Last year’s tech rally was fueled in large part by a gamma squeeze spurred by call buying in names like Netflix Inc. and Apple Inc. In a world of soaring megacap valuations, the thinking goes that the same forces could be unleashed in the opposite direction with derivatives betting against such names.
“Where a put-option gamma squeeze becomes much more dangerous is in mega cap tech names that comprise the indices,” according to Garrett DeSimone, head quant at OptionMetrics, a data provider. “These are much more liquid stocks and have the ability to impact the broader indices and ETFs.”
According to Credence Capital Management trader Yannis Couletsis, that kind of liquidity would be the very thing to save the situation. He reckons even if a negative gamma squeeze occurs, real-money buyers are likely to step in and that will ensure the fallout is short-lived. “I would not expect it will provide dramatically meaningful fuel to the fire except for the first couple of days,” the volatility trader said.
Put Power
However long it lasts, the effects could be significant. A particular concern is that a gamma squeeze to the downside could actually be far more powerful than one that sends stocks higher. That’s because market makers are short puts across their business thanks to persistent demand for stock hedges.
It’s different for calls, where liquidity providers are overwhelmingly long thanks to the boom in call-overwriting strategies that involve selling the bullish contracts, according to Aegea’s Karsan.
All that means if the masses get involved in put buying, it might force dealers to offload the underlying shares at a fast clip and trigger waves of selling.
“Negative gamma is much riskier because downward volatility is a stronger feedback loop,” said OptionMetrics’ DeSimone.
example discussion: Reverse gamma squeeze incoming
- 02/11/2021 – I missed GME Gamma Squeeze even though I looked at GM in 2019 but did not fully understand it. Look closely down below on “What can create the conditions for a gamma squeeze to occur?” Can I get my Gamma Squeeze next time? How to find it?
What Is a Gamma Squeeze?
Add the complexity of options to the forced buying behavior of an ordinary short squeeze, and you can wind up with an even crazier situation.
In investing, a “squeeze” typically refers to times when rapid price movements in a company’s stock force investors to make changes in their investment positions that they otherwise wouldn’t. Those forced moves often drive even more price changes and forced moves, creating a nasty feedback loop that can last quite awhile before it crashes.
One of the more common types of squeezes is known as a short squeeze — when a rising stock price forces people who had sold the stock short to buy back those shares, driving stock prices higher. Related to the short squeeze is something known as a gamma squeeze.
A gamma squeeze takes things one step further, forcing additional stock-buying activity due to open options positions on the underlying stock. A gamma squeeze is behind a large part of the recent meteoric rise in the share price of GameStop (NYSE:GME).
Why options trading can create stock volatility
Options are traded a little bit differently than stocks are. When you open an options contract, chances are that you are not trading with another individual investor, but rather with a market maker. You and your counterparty (typically the market maker) are likely creating the options contract — both the assets and the liabilities they entail — out of thin air, within the structure of standardized contracts.
Market makers aren’t entering into these transactions out of the goodness of their hearts, but rather to make a profit from the trade. The market maker typically uses a sophisticated pricing model known as the Black-Scholes options pricing model to figure out what the option should cost.
The price at which the market maker will actually trade with you generally figures in a bit of a statistical profit based on that pricing model. On top of that, the market maker will likely use a little bit of that potential profit, along with other capital, to hedge his or her bets by buying or shorting stock, depending on the option in question. It’s that hedging activity that can create the conditions that make a gamma squeeze possible.
It’s all Greeks to me
The Black-Scholes model doesn’t just spit out a price for an options contract. It also enables the calculation of a number of risk measures based on that price that are collectively known as the Greeks. One of those Greeks — known as gamma — is often used by market makers to figure out how much to hedge their bets. Gamma is a derivative of delta (see below).
The higher the delta, the larger a stock position the market maker will need in order to have an effective hedge against open options positions. As a result, as delta changes, market makers with open options positions are often forced to buy or sell the underlying stock to keep their own books properly hedged. Large amounts of that forced buying or selling activity is what creates a gamma squeeze.
Where does gamma come from?
To understand gamma, you first have to get a handle on an option’s delta (another Greek), which represents the expected change in the price of an option based on changes in the price of the underlying stock. For instance, if a call option has a delta of 0.2, its price is expected to rise about $0.20 for a $1 rise in the underlying stock. An option’s delta will change based on how far away the stock price is from the exercise price of the option, and in which direction.
The chart below shows a sample graph of what an options delta chart would look like for a long call option on a stock. A long call option gives its holder the right to buy 100 shares of stock at a given price, while the seller of the option will hold the reciprocal obligation to sell those shares at the exercise price. Looking to the chart, option delta is a nearly flat line around zero when a stock’s price is well below the option’s exercise price. It is also a nearly flat line around 1 when that stock’s price is well above the option’s exercise price.
CHART BY AUTHOR.
In the middle, though, that delta chart curves upward, reaching a value of 0.5 and reaching its steepest slope at exactly the option’s strike price. It’s the slope of the option’s delta chart that represents the option’s gamma, and that slope is at its steepest — and thus the gamma is at its highest — at exactly that option’s exercise price.
What can create the conditions for a gamma squeeze to occur?
In GameStop’s case, many people have long expected the company to be forced to declare bankruptcy, thanks to a business model that has been largely disrupted by digital downloads of games. When they expect such bad news, investors may be tempted to borrow and short the stock. So many people had made that decision regarding GameStop that more than 100% of the company’s total float had been sold short at one point.
Because of the potential for a short squeeze, some investors who short stocks don’t simply sell a stock, but rather they cover their shorts by buying long, offsetting, out-of-the-money calls (i.e. exercise price of the call is above the price shares trade at when the calls were purchased). Say an investor shorted 100 shares of GameStop at $10 per share back in October 2020. That investor could have bought a $15 call option to cover that bet for a fairly cheap price back then.
That would have protected the investor from a short squeeze causing a spike in GameStop’s price, at the cost of some of the potential profits if the company’s shares did continue falling toward zero. The market maker on the other side of that options trade would have probably used a gamma calculation to help determine how many shares of GameStop to buy in order to set up a hedge.
Fast forward to January 2021, the GameStop short squeeze is in full swing. GameStop’s challenging fundamentals haven’t dramatically improved, but the stock price is much higher thanks to the short squeeze. That higher stock price attracts even more short-sellers, who want to profit from the even deeper distance GameStop’s shares may fall.
Some of those new short-sellers in turn buy more out-of-the-money long call options to protect themselves from the possibility that its shares will rise further. On top of that pressure, speculators who are betting the stock will continue its meteoric rise may also be buying out-of-the-money call options in the hope their bet pays off. Especially if there isn’t much time value left on those call options because they’re close to expiring, the risk/reward trade-off can look mighty tempting.
That forces the market maker on the opposite side of that options trade to buy more shares to hedge, which in turn causes the stock to rise more. As the stock rises to approach that option strike price, the market maker is forced to buy even more shares as a delta hedge, and thus the stock price goes up and you wind up with a gamma squeeze.
What goes up, will very likely come down
The key thing to note about gamma squeezes, though, is that they are often very sharp, double-edged swords. Just as they can force buying pressure, they can also force selling pressure. Recall that gamma is based on the slope of that delta chart above, and that chart has the steepest slope (and thus, the most gamma) at exactly the option’s strike price. Get too far away from that price, and gamma starts to fade, reducing how frequently the delta hedge for that contract needs to be adjusted. However, keep in mind that the market maker has a portfolio of other contracts that still require hedging.
Likewise, as those options contracts close, are exercised, or expire, the market maker no longer needs to hold a hedge against an options position that no longer exists. That also reduces the buying pressure on the stock, which could cause the squeeze to reverse itself.
No matter what the driver of their eventual reversal, gamma squeezes don’t last forever. And when they reverse, the move in the opposite direction can be just as gut-wrenching (if not more so) than the initial squeeze itself was.
Either way, volatility during and immediately after a gamma squeeze is usually extreme, and predictability goes straight out the window. As a result, whether it’s with GameStop or any other company going through a gamma squeeze, the best thing to do might just be to wait until it’s over. Once it’s over, you can look through whatever wreckage remains and determine whether it offers you an investment opportunity you really want to take advantage of for the long term.
- 02/10/2021 – understand Greeks
Using the “Greeks” to Understand Options
- 01/27/2019 -Here are some learning about OTC stock options
I have called etrade customer service and got informed that they currently do not offer options for FNMA/FMCC. I have also called Gain Capital, they also cannot do.
What are OTC Options – from investopedia
OTC options are exotic options traded in the over-the-counter market rather than on a formal exchange. There is no standardization of strike prices and expiration dates, so participants essentially define their own terms. As with other OTC markets, these options transact directly between buyer and seller. There is no secondary market.
Because buyers and seller deal directly with each other for OTC options, they can set the combination of strike and expiration to meet their individual needs. While not typical, terms may include almost any condition, including some from outside the realm of regular trading and markets. There are also no disclosure requirements, which represents a risk that counterparties will not fulfill their obligations under the options contract. Also, these trades do not enjoy the same protection given by an exchange or clearing house.
Finally, since there is no secondary market, the only way to close an OTC options position is to create an offsetting transaction. An offsetting transaction will effectively nullify the effects of the original trade. In contrast, the holder of an exchange-listed option may merely go back to the exchange to sell their position.
Overview
In 2014, OCC began offering clearing services for OTC products on S&P 500® index options. Transactions are transmitted to OCC via an approved OTC Trade Source and are guaranteed by OCC through a similar novation process as other OCC cleared products.
OTC options must be negotiated and matched OTC (not transacted on an exchange or exchange-like market). Clearing member clients must be eligible contract participants.
SEC No-Action
Following is a “no-action” letter from the SEC to OCC with respect to cleared OTC options and Exchange Act Rules 15c3-1 and 15c3-1(a). OCC received no-action relief from the SEC to permit OTC options to be treated the same as other listed options for purposes of Rule15c3-1, enabling broker dealers to use an approved theoretical options pricing model to calculate capital charges for positions in OTC options and market makers to trade in OTC options without making themselves ineligible for capital treatment.
In addition, the minimum capital charge for each OTC option under SEC Rule 15c3-1 will be $0.75, adjusted as appropriate for the size of the OTC option, not to exceed the market value in the case of long contracts in OTC options.
- 01/27/2019 How to Buy Penny Stock on Margin – if the margin requirement is high (>50%), then it is not worthwhile to trade in margin given it is possibility of margin call
OTC Stock List
The Federal Reserve Board usually publishes a list of stocks that can be bought on margin, published quarterly. It includes the names of public companies that either abide by the rules of the National Market System or those that trade on the national securities exchanges. Since penny stocks do not trade on the national securities exchanges, investors should first consult the list of OTC stocks for companies that can be bought on margin.
Margin Levels
The Federal Reserve sets the minimum requirement or the margin level that investors can buy stocks on credit. For many blue-chip stocks, the margin requirement is 50 percent. This means an investor who has $10,000 cash in their trade account can be allowed to borrow an additional $10,000 shares of stock. For penny stocks the margin requirement can be up to 100 percent, which means investors have to put down the full cash amount to make the purchase .
