What do you mean – Gamma Exposure?

I expand on all things gamma in another article that dives deeper into practical trading ideas around gamma exposure and OPEX.
New data reveals in this article that the gamma exposure effect is getting stronger than ever.
Find links to the complete article series at the end of this post.

Do you also frequently stumble across someone saying or writing: „options market makers need to delta hedge their gamma exposure“ or something similar? But what does that even mean? And is there any useful information to be gleaned or is it simply gobbledygook investment professionals sprout to make themselves seem smarter than they really are?

I think, the best trading edges arise when market participants are forced to act in a certain way – and that seems to be exactly what is playing out here, beneath the surface of the market. The strongest effect is visible in the S&P 500, because it is such a widely traded index.

The mechanism behind gamma exposure

Market makers buy and sell options from and to traders and must hedge their market risk by buying or selling the underlying equities or futures, if they want to avoid going broke sooner or later. This process is complex, because options move differently in comparison to the underlying market depending on how far away from their strike price they are (the delta) and this sensitivity changes constantly. When dealers are highly exposed to this change (the gamma), they need to buy or sell futures with every point the market moves to adjust their hedge (delta hedging) in order to stay neutral to its direction.

Now this dealer gamma exposure can be long or short with opposite effects (which causes a lot of the confusion and cryptic charts as the example below from Spotgamma) and can amount to billions of dollars of forced supply and demand for each point the S&P 500 moves.

Long gamma
If they are long gamma, then for each point the S&P 500 moves up, dealers have to sell equities or futures by the net gamma amount (see chart), when it moves down they buy. Volatility is suppressed by this constant force of supply and demand counter to the market´s direction – this is what we often witness in the form of slowly rising markets or long sideways moves oscillating in a tight range around one price point. Price seems to be „pinned” to a certain level.

Short gamma
Here the reverse effect takes place: for each point the S&P 500 moves down, dealers have to sell equities or futures and vice versa, thereby exacerbating the market´s move. Volatility spikes and suddenly stocks are going crazy.

The zero gamma level
At a certain point in a falling market long gamma switches to short gamma (the „volatility trigger“ or “zero gamma level“ in the chart) – a key area around which market behavior can change dramatically.


Monthly option expiration
On expiration days delta and gamma exposures often change significantly depending on how expiring options contracts are rolled forward, which can cause sudden jumps in market price as dealers hedge these changes. As the effects of gamma exposure also expire, significant market moves and turning points often happen around monthly OpEx dates.

Tradable ideas

  • At the zero gamma level, the switching point from long to short gamma, we often see a strong reversal to the upside, because the level acts as a reliable support area.
    But when price breaks through to the downside, we can expect much larger daily moves in either direction than we saw before. This often coincides with a volatility spike and an inversion of the VIX futures term structure (a warning signal for elevated risk in the market).
  • There has been a tendency for markets to rise in the week before the monthly and quarterly option expiry dates.

Access to sophisticated research and precise modeling used to be the domain of large institutions, but today anyone can get easy access to accurate information that is modeled from options data by, for example, Squeezemetrix, Nomura or Spotgamma.

In my weekly premium report, I provide current gamma exposure levels and give tradable ideas based on current market situations. Learn more and subscribe here or view a free sample here.

Articles in the series

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  • Great article, thank you. You mentioned resources from Nomura. I could not find them, do you possible have a link? Thanks

    • Thank you! There used to be frequent free analysis by Nomura’s Charlie McElligott on zerohedge.com, but it seems to have gone behind a paywall recently — otherwise he provides institutional research that may be hard to get.
      I went back to check for free sources available as of January 2021: GEX at Squeezemetrix and Trading Volatility via Twitter (frequent gamma exposure and zero gamma levels).

      • I’m not sure — best ask squeezemetrics as I’m not affiliated with them…

      • I have a few questions about :
        1- Is there a specialized dealer in the Sp500 futures market?
        2- There are many expirations, the weeklies have much volume. Why vanna and charm effects are considered only for the monthly expirations?
        3- In my understanding in a quietly rising market the dealers’ position is net long gamma with it’s book long OTM calls and short OTM puts. So it means that the purchased calls are more than the sold puts. That’s because there’s less need for protection?
        Thank you very much

  • In your very interesting article I read: “Market makers buy and sell options from and to traders and must hedge their market risk by buying or selling the underlying equities”
    My question is: The market maker in the equities market do just the opposite hedging their market risk by buying options?
    What kind of effect the activity of “equities market makers” produces in the market? Is there a similar “gamma effect”?
    I hope I made my question clear.
    Thank you very much!

    • Not nearly as noticeable as far as I know. The main difference is that those hedges are usually very short-term, as market makers don’t tend to hold equities on their books for very long.

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