How Limit Order Book Depth Can Affect Volatility and Trading

# What is the effect of increasing volume depth to stock volatility?


# What is the effect of increasing volume depth to stock volatility?












Say, an investment bank want to hedge its Long Gamma position on its Long Call option by placing limit orders in the exchange. Limit orders result in increasing volume depth.

Empirically, what is the effect to stock volatility?

Does the increasing depth make it harder for stock to move up or down?

Does the increasing depth attract other market participants to trade stocks and improve price discovery?

## Answer by amdopt (score 4)

https://quant.stackexchange.com/a/32442

Answers to your 3 questions:

- Empirically, there is no effect. I understand that this is not logical but it is reality.

- Adding thickness to an order book does not necessarily make it harder or easier for a stock to move. If your order is static it will be recognized quite quickly and used by other participants for liquidity.

- It will attract participants but not necessarily to improve price discovery. It may attract predatory traders as well that could increase short term volatility.

Regarding the first sentence of your post...if you are concerned about the long gamma exposure of a long call option you must be holding an option that is very close to expiry and very close to being at-the-money. There are far more effective ways to hedge/mitigate that risk rather then trying to stack an order book at an expiration to make a stock appear stable.

## Answer by nbbo2 (score 1)

https://quant.stackexchange.com/a/32425

limit orders (buy orders below the market, sell orders above the market) obviously reduce volatility all other things constant, by acting as a kind of partially absorbing barrier against incoming trades (i.e. makes it harder for noise traders to move the price up or down).

On the second question liquidity is to some extent self-reinforcing, more depth means lower transactions costs, which attract more traders, which further increases depth and liquidity and at least in theory leads to better price discovery (now we are taking about the information traders).

## Answer by nimbus3000 (score 1)

https://quant.stackexchange.com/a/32436

Consider this: If there is infinite volume available at both bid and ask, then the price of the asset will never move irrespective of the size of the incoming market order, the mid will always be the same. 0 volatility.

There are traders who use quantity available at a price as a resistance and support and trade accordingly.

## Answer by Nivel Egres (score 1)

https://quant.stackexchange.com/a/32455

Once your daily gamma start approaching a reasonable fraction of DV, those resting order will start killing vol (if anyone tells you otherwise, they just haven't reached that threshold). Usually you see this effect on large corporate trades such as ASRs or large stake acquisitions.

As an curiosity, one of the HF traders used to be called "the put bomber". He'd quote a high gamma put (gently OTM) on a semi-liquid stock and hit a few desks at once. Obviously, once the size in the market was meaningful, the vol would be squashed from delta hedging. Eventually, most people cut him off, of course.