Pakstan on the Hudson

I don’t care if Monday’s blue
Tuesday’s grey and Wednesday too
Thursday I don’t care about you
It’s Friday, I’m in love

The Cure

So I asked a specialist friend for a size market in some financial put, he told me I could go ………nevermind. As I look now, GS Oct puts are quoted $3 wide or so bid to ask, roughly 10 up (the quantity of contracts bid and offered). MS markets a little deeper, though very wide. Especially so considering it’s only a $26 stock.

What I am waiting for though is a perp. walk from someone who is assigned some GS calls after the close today. Oh, the Humanity!

Anyway, nothing I like better than cutting and pasting something I already wrote. And as long as the Ben and Hank are going to time their biggest ammo to kick in before the market opens on Expiration Friday, I’m going to keep running this as my description of just what it is they are doing to options shorts.

So without further ado, this from August 07 when Big Ben made it rain with a surprise Discount Rate cut pre-open.

So how does putting a market-moving Fed action as close to expiration as humanly possible have the maximal turbo effect? One word: Gamma.

Consider a world where there is just one option, ATM SPY calls. They have a 50 delta, so let’s say there is an open interest of 100 where each call gives you the right to buy 100 SPY’s. If they are ATM, the calls have approximately a 50 delta, so presumably the call shorts own 5000 SPY’s, while the longs are short the SPY’s.

But the delta changes as the stock moves. That’s the gamma. Let’s say the gamma is 10, so in other words if SPY lifts a point, the calls now have a 60 delta. The longs can thus sell 1000 SPY’s up a point, while the shorts have to buy 1000 up a point in order to both stay flat. The quantities are always going to offset, options are a zero sum game, so it becomes all about the urgency of the two sides.

And who has more urgency lately? Clearly the options shorts. So it stands to reason that the higher gamma gets, the more turbo in the stock.

The closer you get to expiration, the higher the gamma. And the more pressure on the side that is squeezed. In other words with a few days to go, maybe that gamma is 20. So a one point move causes the scrambling shorts to buy 2000, while the longs can sell 2000, probably at prices more their liking.

And what if it turns back down to the strike? The option shorts now have to sell back those 2000 shares to flatten out again. And so on and so forth.

And then the next day maybe they have 30 gamma near the money. Even more pressure in each direction exerted by the shorts in this environment.

Which brings us to Friday. Gamma is essentially infinity in the SPX August options. They have stopped trading. They are merely cashed out at the "opening" price (defined as whatever the calculation formula spits out taking the opening tick from each component). The rate cut and market pop comes an hour and change ahead of the open. All a call short can do to defend his position is chase futures/ETF’s up. Some OTM calls he is short now have a 100 delta between now and the open. Sure there is an offsetting long that can sell the futures/ETF’s, but who has the urgency here? Clearly the squeezed short. And thus the kindling wood lit by the Bernanke match.

Throw in a similar dymamic on all other index/ETF options that expire at the end of the day, and Big Ben literally found the perfect minute to cause the most pain to options sellers.