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Using FX Options Open Interest to Study Dealer Gamma Effects

Article Quant Q&A · Author: beeba
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Summary

The document proposes a hypothesis about how FX option dealers’ aggregate gamma exposure may affect spot-market behavior. Dealers who are long gamma are described as hedging in ways that could dampen price moves, while short-gamma hedging could amplify them. The question is how to assess dealer positioning using public market information.

The response says aggregate dealer positions may not be freely available and suggests a preliminary proxy: compare option open-interest notional with daily underlying trading volume in notional terms. A high ratio could indicate greater potential for hedging flows to affect the spot market, and could help select currency pairs for further study. This is a screening idea, not a direct measure of dealer gamma or evidence that hedging causes observed price patterns. The document recommends looking for specialized data vendors if position data is needed; it provides no empirical test or results.

Key ideas

  • Dealer gamma exposure may influence whether FX spot moves are dampened or amplified by hedging flows.
  • Public data may not reveal the aggregate option positions held by market makers.
  • Comparing option open-interest notional with daily spot turnover can help identify pairs for an initial study.
  • A high open-interest-to-volume ratio indicates possible market impact, not proof of it.

Tags

ForexOptionsMarket microstructureDerivatives pricing
Full text
# Using Market Gamma to Predict FX Trading Environments


# Using Market Gamma to Predict FX Trading Environments












I want to test a hypothesis about using gamma to predict FX movements.

Suppose that market makers will seek to be delta neutral given their portfolio of FX options. At any given time, market makers in the interbank market will be either long or short gamma in the aggregate for their portfolios of FX options. If they are long gamma, market makers as a whole will delta hedge by engaging in strategies such as continuously buying the spot when it is low and selling it when it rises, meaning the spot range will operate in a relatively tight band. The opposite will hold if market makers are net short gamma, with the spot swinging widely.

If I have access only to public information (eg anything on Bloomberg Terminal) how can I identify whether market makers are long or short gamma for FX options in order to test this hypothesis?

## Answer by Escachator (score 1, accepted)

https://quant.stackexchange.com/a/24751

If I understand your question, you are looking to find what is the overall position of each option for all market makers. I don't think this information is available for free in Bloomberg. It may be available in some specific vendors: I remember to purchase this exact information for Apple options, but I don't think it was available for FX options in the vendor that I purchase it to.

If your hypothesis is that the gamma hedging is having an impact in the underlying, a starting point could be to compare the total notional of the open interests with the daily trading volume (in notional terms) of the underlying. If this ratio is high the probability of market impact of the gamma hedging increases. The initial study can lead you to select the FX pairs with the highest value of this ratio. Once you have it, I recommend you to research different vendors to see if that data is available.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.