Beware of Greeks

The market keeps accumulating risks on is daily climb of the wall of worry. At this point in the market at all time highs, investors demand protection, as they want to hedge the gains they have accumulated over months, perhaps years. But they also speculate, as we enter the phase of euphoria. In that risk transfer exercise, the problem ends up on the desk of option dealers. The chart below shows the amount of gamma for the S&P500 and Nasdaq ETFs. Gamma basically shows the “speed” of how quickly an option’s value adjusts to changes in the price of the underlying ETF. When gamma is big and negative, like today, option dealers need to sell aggressively when the price of ETFs fall. To put it in layman’s terms, they need to accelerate on a downhill. That will amplify any downward move and accelerate it. You can argue that $8Bn of gamma in a $50Tn market is not much, but we need to consider that is extra risk to the one of the ETFs, which need to sell the underlying basket of stocks as investors sell, creating a snowball effect. And this is just the gamma for 2 ETFs, albeit the biggest ones. To add insult to injury, the net short VIX futures position is the biggest one since 2022, as volatility harvesters keep milking the strategy. That will squeeze them on a downward move. Now imagine that NVDA results today are good, but they lower future expectations. It weights 8% in the S&P500 and almost 10% of Nasdaq.

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