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Options and Monday’s Lows

Posted By Barry Ritholtz On October 16, 2007 @ 9:25 am In Markets,Options,Trading | Comments Disabled

Gammavsunderlyingprice [1]
Sometimes, short term mechanical concerns can magnify market moves.

Example: Consider option gamma and this week’s option expiration on Friday.

Very often, as we get closer to expiration, the underlying relationship between equities and their options can exacerbate market moves in both directions. Given the recent move off of the peak highs, and where many option traders made their purchases, the potential to dramatically impact downside action exists.

That’s especially troublesome if Monday’s lows on stocks are violated.

I am oversimplifying, but if Monday’s lows are breached, the ‘gamma’ effect of options may come into play. Gamma = Change in Delta/Change in Underlying Asset. As out of the money options go ‘into the money,’ it could force traders to rebalance their hedges, which in turns further aggravates the move to the downside.

As we get closer to Friday’s expiry, there is little premium left on expiring options. That can create a more intense gamma effect. (Options traders:  Please  correct my phrasing; I was never a trader on an option desk, and I may be misusing terms of art) .

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This is merely a short term trading observation. Just an FYI . . .


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