It comes from the Black-Scholes equation for pricing derivatives. It's a partial differential equation that's defined in terms of the price of the derivative, the price of the underlying asset, volatility, and time.
From the equation, you can derive a series of rates of change one one variable with respect to another, often colloquially known as "the greeks", since they're all denoted with greek letters.
The first one to know is delta. It's the rate of change in the option's price with respect to the underlying asset's price.
Delta generally follows a curve, not a straight line. Gamma is the rate at which delta changes with respect to the underlying asset's price.
The reason why these are a big deal are because options traders often try to remain "delta-neutral" - they want the overall delta of their options portfolio to remain close to zero, which limits the effect of fluctuations in the underlying asset's price on the overall value of their portfolio. But that's a constant balancing act, because changes in the underlying asset price also change the delta of their position. A low gamma means that it changes slowly, and it's easy to keep things balanced. A high gamma means that they're sitting on an unstable equilibrium, and they're going to have to buy and sell more aggressively in order to maintain their position.
why do they want delta neutral, if you are buying option don't you want delta as high as possible and if you are selling option don't you want delta as low as possible ?
I think the GP misspoke when they said "option traders". Market makers want to be delta-neutral -- they don't want to care whether the underlying goes up or down, since they buy and sell both puts and calls and profit from the bid/ask spread.
Your description is right(-ish) for directional traders.
The basic mechanism of this, in my understanding is:
1. Buy underlying shares.
2. Buy calls on those shares.
3. Market makers who sell you those calls have to buy shares in the underlying stock to hedge (they run balanced books)
4. Demand for stock rises, stock price and calls increase in value
5. Use proceeds to buy more stock and options. Rinse, repeat.
The "gamma squeeze" (which is how much the option value changes in relation to underlying stock price) refers to the part where options sellers have to hedge by buying stock. Essentially, the very act of buying calls in volume increases their value, allowing you to buy more and drive the price upwards.
You forgot "6. Sell all underlying shares and calls before everything collapses". At some point, market makers shouldn't be able to sell you more calls. That's when you dump.
Ok, for all of you out there who think this is so illegal... you’re confusing immoral vs illegal. Anyone who buys large amounts of a financial instrument is knowingly influencing the market price. Some folks on here have mentioned Berkshire Hathaway, who is notably trying to NOT inflate prices while buying; the mere knowledge that they are tends to send prices higher. What SoftBank did is probably wrong, but it’s not illegal. The markers are a casino, it’s all betting prices go one way or the other. SoftBank doubled down on their purchases through options, which is legal. The point up for debate is intent, if they intended to manipulate prices, they are criminals. But when has anyone ever proved intent alone? That’s not an avenue to enforce market regulations, that just leads to thought police. What we all need to accept, is that no matter what financial transaction rules are in place, someone, somewhere will find a way to manipulate them to their advantage without overtly breaking them. It has always been this way, and always will. The smart win, and the fools are quickly parted from their money. Stop bitching, and stop buying Tesla at a 1200 PE. Xoxo xoxo - me
Regardless of intent, or if manipulation is happening in this case, or whether or not it is currently legal, this type of activity potentially allows for someone to artificially manipulate prices to their advantage at the cost of other market participants. Hence, why shouldn't we make such activity illegal for this reason alone? Why leave a now obvious loophole in our financial system, that could be potentially be abused? We made wash sales trading illegal. Why shouldn't this pattern of activity also be made illegal - when wash sales trading is deemed illegal?
If your argument is abuse will happen anyways - why even bother having any financial laws?
I understand your surprise here, but just to note: lay people intuitively think that "stock manipulation" is a crime. This is because their retirement savings relies on stock prices being fairly stable due to attachment to actual business value. Intuitively, people that put that system at risk are doing something wrong, and things that are wrong should potentially be illegal.
Essentially: most people intuitively think the stock market should be more heavily regulated than it actually is.
This is why I wish I had a pension instead of a 401k. Too bad that the people who still offer pensions are also paying a lot less on average (usually due to being government related) than companies offering 401ks do.
The US Securities Exchange Act defines market manipulation as "transactions which create an artificial price or maintain an artificial price for a tradable security".
Buying and holding call options is not market manipulation, full stop. Please provide an example of someone being penalized by the SEC for buying and holding call options without using insider information. You won’t, because buying call options is not market manipulation.
Is it market manipulation when Buffett announces BH bought shares of a company and then the shares skyrocket?
Legally it depends on intent, which would be very hard to prove. Unless senior execs wrote emails saying “let’s buy option to manipulate the market” or colluded with other market participants, it is safe. However, it is not “always” safe.
I never claimed someone was ever penalized by the SEC for buying and holding call options, just that buying derivatives can be a crime if it's done for the purpose of market manipulation.
Part of the difference here is that BH is legally obligated to disclose when they buy shares of companies. At least, they are under certain circumstances, which I can’t remember off the top of my head. You can’t punish someone for something they’re legally obligated to do, because one can’t be legally obligated to commit a crime.
Lots of things where once legal, which the majority of society came to deem as bad (slavery, child labor) - which we then came to make illegal.
But the problem here isn't just simply buying stocks, or holding options. It's the repeated process of buying both a stock and its options at the same time by a whale - and it seemingly does allow for manipulation of stock price. As so, why shouldn't such a pattern of activity be made illegal?
Eventually the “manipulation” will push the price to a point where other actors sell, and then more people sell and the price corrects (see yesterday and today’s charts). Buying equities and options in large amounts is not market manipulation. There are lots of institutional actors placing large orders all the time.
>Eventually the “manipulation” will push the price to a point where other actors sell, and then more people sell and the price corrects (see yesterday and today’s charts).
Not sure how this statement helps your argument. The same happens in pump and dumps. The people who artificially manipulated the price up in the first place sell in large, duping the latecomers out of their money, and the price corrects.
>Buying equities and options in large amounts is not market manipulation.
No it is not, but this isn't a simple matter of buying of equities and options. It's a pattern of repeatedly buying equities and options by one large party in a way which allows for potential manipulation. As so, even if such a pattern isn't illegal now, why shouldn't such a pattern be made illegal? Wash trades used to be legal before 1936, but we made them illegal for similar reasons...
Now please explain why this activity shouldn't be made illegal, when wash trading is deemed illegal. Wash trading after all, involves buying stocks... yet it's illegal.
Wash trading is buying and selling to yourself to create the illusion of volume, which is fraudulent. Buying OTM call options on an exchange does nothing to distort volume or manipulate price, it’s simply part of price discovery, just like buying or selling shares.
This scenario is not just "buying OTM call options", just like wash trading is not just "buying stock". This is the problem with your argument. You oversimplify the issue.
Wash trading is a way of buying/selling stock, (namely by one party at the same time), which can be abused to manipulate prices. Just like what is happening here is a way of buying stock and its options (namely by one party at the same time, repeatedly), which can be abused to manipulate prices.
Ought vs Is, my friend. You are making a moral/ethical claim about how the world OUGHT be while he is making the distinction about how the world IS today.
Some patterns are illegal by the way. However proof is still quite difficult to come by.
For instance, it's market manipulation to place large orders continuously and then cancel those orders continuously.
It's also market manipulation to place both LARGE buy and SELL orders at the same time in order to fake volume for a particular stock.
However me as an individual or private entity can at any time go place an a LARGE as fuck order for what ever I want.
In fact if you look back and study old stock floors ect. traders started to learn what the people at the large banks/intuitions looked like. When they saw them walk up with their stack of PHYSICAL orders, they'd try and step in front of them because they knew the market was about to move as a large order was about to be placed.
Shares prices are falling today. People are selling. That means people are also buying. Every transaction has a buyer and a seller. Yet prices still fall.
Let me rephrase: Buying a huge volume of shares equivalent to SoftBanks option delta exposure would raise the share price of whatever underlying the options were for.
On one hand, it's purely mechanical; it just works that way. On the other, it's hard to imagine doing it deliberately wouldn't be considered manipulation.
The purpose of buying call options is to to make a profit. It's hard to imagine that buying them and doing nothing other than buying them could be considered illegal. That's not manipulating the system any more than Buffet manipulates the system every time he buys stock (by also sending out the message that he thinks the stock is worth buying, just because he bought it without even needing to say anything about it).
The sheer magnitude of it is what makes it seem like a pump and dump, however. The mechanics are broadly similar: send a signal that should cause people to bid up securities you own, then drop the bottom out by selling when the price goes up enough.
I’m not saying it’s illegal per se, but financial misdeeds don’t tend to get punished in the US, unless the victims are wealthy enough. See, for instance, the global financial crisis of 2008 vs Bernie Madoff.
It would come down to intent. If the intent of buying a lot of options is, "I want a big position," or, "I want to hedge a big position," sure, that's probably fine. If the intent is, "I want to influence the market in some way," not so much.
That last "if" is the crux. Intent is a huge factor in what is and is not considered legal market behavior. For example, consider banging the close. Buying lots of futures at a certain time of day is not illegal in and of itself. But it's quite illegal if regulators show that your purpose in doing so was to influence the settlement price of some other asset in which you hold a position.
Insider trading drives prices closer to fair value. A CEO dumping shares before reporting a bad quarter saved money for unknowing purchasers buying the stock. If the CEO buys shares before reporting a huge new government contract, they get a better price for clueless sellers.
Now public companies could still restrict CEOs and other employees from profiting from insider knowledge. It could even be as simple as requiring employees to file disclosure filings before any stock transaction to level thevplayomg field.
I think he means that in technical analysis, they trade based on price action. Thus, insider trading gives you a peek into something that the fundamentals haven’t revealed yet (the price will change to reflect the secret news).
Also, gamma has a kind of self-reinforcing feedback loop. When the options are initially way OTM the market makers only need to hedge with a small amount of the underlying. But as the price runs closer to the option strikes the delta impact of a given move becomes larger and larger, so MMs have to hedge with more and more of the underlying, which can itself push the price farther in the same direction.
Yes, obviously the reflexivity does not proceed ad infinitum, but these dynamics are often responsible for extremely violent moves in the short term. The effects can be even more pronounced right before expiration.
Indeed, gamma squeezes can produce lots of volatility near OpEx. And call rolling can just push the gamma further out for another squeeze come the next OpEx.
So that would imply that for Softbank, high gamma stocks are desirable for this scheme? As in they want the maximum 'reaction' from each purchase they make?
Also, this works in reverse right? So Softbank is literally just creating a stock market bubble since the price rises are not built on anything fundamental?
I think how much of a bubble depends on the specifics of the stocks they're doing this with.
If the stocks they're choosing have high gamma because there's a lot of short interest, then some of this increase could be shorts transferring equity to longs when they cover, which wouldn't be a bubble per say.
Historically low interest rates could also fuel this directly by providing extremely low interest capital and indirectly by pushing investors in general to chase yields in equities. That would be more bubble-like, but it also applies to other asset classes, and it's ultimately a function of central bank policy.
To clarify it’s actually the second derivative of the options price w.r.t the underlying price, whereas “delta” is the first derivative of the same. (So gamma is the rate of change of delay w.r.t the options price since delta is not constant)
Gamma is the rate of change of delta w.r.t the underlying price. For example OTM calls have a delta close to 0. As the underlying price increases the delta will increase. When the underlying price reaches the call strike price (ATM) the delta will typically be 0.5. As the underlying price continues to rise and the call becomes deep ITM the delta will approach 1.0.
In the context of options, delta is the change in the option price divided by the change in the price of the underlying stock (i.e., the first derivative w.r.t. the stock price).
Gamma is how much the delta changes for a change in the underlying stock (i.e., the second derivative w.r.t. the stock price).
Market makers hedge their options positions by buying or selling the underlying stock so that they have no exposure to moves in the underlying stock (they are "delta neutral"). So if the delta at the current stock price is 0.50 and the market maker is short 100 call options, he will buy 50 shares. But options are non-linear and the delta changes with the stock price (again, this is what gamma is). If the stock moves up so that the delta increases to 0.60, the market maker will need to buy another 10 shares so that he owns 60 shares and is again delta neutral.
In this way, buying begets more buying and this is what people mean when they talk about a gamma "meltup".
So if the delta at the current stock price is 0.50 and the market maker is short 100 call options, he will buy 50 shares.
If he does that he won't remain a market maker for long.
A single call option almost always is for 100 shares of the stock. So being short 100 call options, delta 0.5, would require being long 5000 shares to be hedged.
I'm sure you knew that, I'm just pointing out your typo for other less-experienced people here.
It’s the second derivative of option price w.r.t asset price.
The first derivative “delta” is the speed at which the option price moves w.r.t the asset price. If the option is “deep in the money”, it’s almost 1 - any move is the asset price is essentially also the same move in the option price. If it’s deep out of the money, it is almost 0 - the probability of the option being worth anything is almost zero, so it’s value doesn’t change with price moves. It is 0.5 at the money (but i don’t have a one line intuitive explanation)
Gamma is the acceleration of option price with respect to the asset price. If the asset price grows, how will the delta (speed) change?
