Trading
options
market making
MM buys and sell options and earns the bid-ask spread.
Suppose MM sells a 1 call option contract, making him delta negative. He needs to hedge the negative delta by buying the underlying equity. If the delta is 0.05, then on 1 option contract, he'd need to buy 5 shares of the underlying equity. With 1 short call and 5 shares, the MM becomes delta neutral.
If the price of the underlying goes up, the call option delta also goes up. This means the MM is again not hedged. For example, if the delta goes to 0.10, the MM would need to hold 10 shares. Since he already holds 5 shares, he'd go buy another 5 shares for a total of 10 shares- making him delta neutral.
Now if the call becomes in-the-money and the delta reaches 1.0, the MM needs to hold 100 shares of the underlying, in the event the call holder exercises and the MM needs to hand over the 100 shares.
implied volatility
Once news about a company goes public, the IV should go down- because the unknown becomes known. When the IV goes down, option prices go down as well- because by definition, option prices are built on intrinsic and extrinsic information. IV is part of the extrinsic.
extrinsic value
The more time to expiration, the more it's going to be worth- from its extrinsic value- made of implied volatility and time value.
calendar call spread
Calendar call spread is a play on IV. A closer to expiration option has lower IV than a longer to expiration option.
Buying and selling of options with the same strike price but with different expirations. A basic calendar call spread would be 1) sell short DTE call and 2) buy long DTE call. The short DTE would have negative vega and the long DTE would have positive vega. Overall, the vega is positive which means for every increase in IV, the overall option price would go up.
vega
Vega is the change in option price for each 1% move in implied vol. This is a first derivative. Vega is higher in ATM options and longer DTE.
gamma
Gamma is the change in delta for each move in the underlying equity's price. In physics terms, it is acceleration, a second derivative.
gamma squeeze
Gamma squeeze is a self-reinforcing push up effect motivated by call option holders. The call seller is required to buy up the underlying equity to delta neutral is short call positions. This buying in effect pushes up the price of the underlying further- which increases the call's delta, further requiring the call seller to buy more underlying. For an equity with few shares outstanding, this behavior induces further buying and higher underlying equity prices.
In effect, the underlying reason for a gamma squeeze are the market makers' need to remain delta neutral.
fixed income
the fed
The role of central banks such as the Federal Reserve- is to maintain a stable and growing economy through price stability and full employment. The Fed has two primary tools in its toolbox:
- Setting short term interest rates. The Fed controls the short end of the yield curve.
- Buying or selling treasury notes and bonds through open market operations.
- Selling bonds to the public takes away cash from the public. This lowers the money supply- and reduces demand for goods. This is a tool to use for lowering inflation. During World War II, Uncle Sam sold bonds to the public not to finance the war, but to reduce demand for other goods and reduce inflation.
- Buying bonds from the public puts money into the hands of the public. This stimulates the economy. This is a tool to use during weak economic times to flood the market with money. "Quantitative easing" is this form of open market bond purchases. Bidding up bonds also causes long term interest rates to fall.