Negative Gamma Explained: Why Dealers Chase the Price (GEX Levels)

The narration of the video, as text.

0:00The question

Negative gamma: what does it mean? Watch the price near a level. It falls, and someone sells even more. It rises, and someone buys. And the moves get wider and wider. Who is pushing the price? And why do traders call it negative gamma?

0:20Welcome

Welcome to the LiveGexLevels guide series: one idea at a time, to read the S&P 500 through options. One note: languages are dubbed automatically, so the voice may sound a bit odd. This is education, not advice: you decide, and you trade with your own broker.

Today: who is on the other side when you buy a put. Then how the market maker hedges it, point by point, and why this time his hedge pushes the price. And finally negative gamma, and the bet the market maker is making.

1:08The other side

In the previous episode, customers sold calls. Now the mirror image: a customer buys a put, to protect a portfolio, like an insurance policy. Someone sells it, and most of the time it's a market maker. The customer buys: pays the premium, and owns the right to sell at the strike. The market maker sells: he is short the put. He collects the premium, and takes on the obligation. Look at the two charts at expiry: the same hockey stick, upside down. What one gains, the other loses. The long put has its own episode in the options school. Here, we follow the market maker.

1:53The put's delta

To hedge, he looks at delta again. A put gains when the index falls, so its delta is negative. Far above the strike, the put barely moves: delta is close to zero. Far below, it moves like a short index: delta is close to minus one. At the money, delta is about minus a half. But he sold the put, so for him the sign flips: plus a half. Selling a put is a bit like being long the index. And as we saw last time, one at-the-money SPX option moves about like one ES.

2:36The hedge

Now the hedge. Customers buy one thousand puts at the money, and the market maker sells them: he is short one thousand puts. For him, it's as if he had bought about one thousand ES: he gains if the index rises, and he loses if it falls. The same bet as last time, so the same first move: he sells about one thousand ES. Puts plus ES: net delta, zero. So far, nothing new. The difference comes when the price moves.

Let's move the index one point at a time, as we did last time. On top, his short puts. Below, his ES. One point down. The puts cost him about forty-nine thousand two hundred dollars, and the ES he sold gain about the same. Total: about zero. Now the index drops one more point. This time the puts cost him a little more, because their delta has grown. The ES gain exactly the same as before. Now there's an imbalance: he is a little too long. To stay balanced, he has to sell more ES. And selling while the price falls pushes it further down. Now the other way. Back to the strike, and one point up: the puts give him about as much as the ES lose. One more point up: the puts give a little less, and the ES lose the same. Now he is a little too short, so he closes some of his short ES, which means buying. And buying while the price rises pushes it further up.

4:21Chasing the price

Let's watch it in motion. The index slips ten points, and he sells about twenty-four ES. Another ten down, and he sells again. It bounces, and he buys back. It climbs above the strike, and he buys more. And when it comes back down, he sells. Every time, with the move.

It's the same delta hedging as last time, with the opposite effect. Then, the market maker traded against the move, and braked it. Now he chases it: he sells when the price falls, and buys when it rises. And every round trip costs him a little, because he buys high and sells low. So why does he accept it? We'll see at the end: it's a bet.

5:11Near expiry

Now, close to expiry. Same put, same strike. Thirty days out, the curve of his delta is soft, spread over hundreds of points. Two hours before expiry, it becomes a step: from almost zero above the strike to almost one below it, within a few dozen points. For the same twenty-point drop, his thousand puts need forty-seven ES sold at thirty days, and seven hundred and forty-three at two hours: about sixteen times as much. That's gamma again, and this time it pushes.

So, two hours from expiry, the same game moves hundreds of ES every five points, in the direction of the move. If the price falls toward a strike where market makers are short many puts, they have to sell more and more, right as it falls. That's why, with negative gamma, a level can become an accelerator instead of a brake.

6:14Who buys

Now a simple rule, worth remembering. Four cases: customers buy or sell, calls or puts. When customers sell options, calls or puts, the market maker is long: positive gamma, and he brakes. That was the previous episode. When customers buy options, calls or puts, he is short: negative gamma, and he accelerates. That's today. What sets the sign is who buys, not whether it's a call or a put.

6:47Negative gamma

So, negative gamma: what does it mean? First: customers bought, so he is short the options. Short options have negative gamma, and the sign that matters is the market maker's. Second: with negative gamma, his delta moves against the price. The index falls, his delta rises, and he sells ES. The index rises, his delta falls, and he buys. Third: he trades with the move. He sells into the drops and buys into the rises, so the price gets pushed, and the moves get wider. In the first episode we said that dealers sometimes brake the price and sometimes amplify it: this is the amplifier. With negative gamma, moves tend to be wider, but gamma doesn't tell you which way.

7:40The market maker's bet

So why does the market maker accept a position that makes him chase the price? Because he gets paid for it. Each put he sold loses a little time value every day, and that value goes to him: about two and a quarter points a day, at thirty days. On a thousand puts, about two hundred and twenty-five thousand dollars a day. On the other side, every move costs him something through his hedging, and big moves cost much more than small ones. The line between the two is about sixty-one points a day. If the index moves less, the time value wins. If it moves more, the hedging costs more. And sixty-one points isn't random: it's the daily move that a fifteen percent volatility implies. Selling the put is a bet that the market will move less than the option's price expects.

Why do customers pay for it? For the same reason people insure a house: the protection is worth more to them than what it costs on average. Protection has a price: options usually price in more movement than actually follows, so over time buyers pay that difference, and the seller collects it. Researchers call it the variance risk premium, and on the S&P 500 our own studies found it too. But the bill doesn't arrive a little at a time. It arrives all at once, on the big days, when the price runs and the market maker has to sell as it falls. That's when negative gamma pushes the hardest.

9:19In brief

In brief. Customers buy the put; the market maker sells it, and is short. He hedges by selling ES, about one for each at-the-money SPX option. Then he keeps adjusting, with the move: he sells when the index falls, and buys when it rises. Near expiry, those adjustments become large flows. Short options mean negative gamma: the moves tend to widen. He accepts it for the time value: a bet that the market moves less than the options expect.

9:55Up next

Coming up in the guide: why positive gamma usually sits above the price and negative gamma below it, and the gamma flip, where one turns into the other. Tell us in the comments where you've seen the price speed up through a level. Before risking real money, practise with paper trading. The guide is free with our newsletter. You'll find it on livegexlevels.com. Knowing where dealers have to chase the price is information a chart alone doesn't give you. Your edge starts with preparation. To see the levels live, sign up on the platform. There's a launch price, and you keep it for as long as you stay subscribed. And there's a free trial.