Good Morning,
- Dealers remain in negative gamma, which leaves SPX in a higher volatility regime.
- Even though markets were calm yesterday, we suspect these underlying conditions were still prevalent. However, since SPX lacked any strong momentum, dealers were able to stay delta-neutral without materially impacting the market.
- This is why we always emphasize that negative gamma creates the conditions for higher volatility, but without the accompanying hedging from market makers, there is no mechanism to drive the realized volatility higher.
- That said, today, we are expecting to see an increase in short-dated implied volatility in the lead-up to tomorrow's CPI release. In a world increasingly dominated by zero-days-to-expiration (0DTE) options, short-dated contracts have become the preferred tools for hedging against single-day risk events.
- This means we typically see the largest jump in IV happen at the front end of our volatility curve, which dealers then broadly hedge with other 0dte contracts without interacting with the futures market.
- Interestingly, the recent rise in implied volatility skew across longer-term tenors suggests that market participants are hedging their exposure to the CPI event not only with 0DTE options but also with longer-dated contracts, particularly 1-month and 3-month put options.
- Contrary to hedging 0dte, when an option dealer sells a longer-term Put contract, they will neutralize their delta exposure by shorting SPX futures, which can introduce some selling pressure into the market.
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-Craig Peterson
