In late December we argued that investors running for protection and buying options as a portfolio hedge would be proven wrong and end up once again realizing they confused the concept of hedging (buying insurance) before the “house burnt down”.
As we have said many times before;
Most investors confuse direction with pace
Our reasoning was basically suggesting that volatilities would come down substantially, but that long gamma would be a good strategy as we expected a violent bounce.
So, what happened?
VIX did implode. It took the VIX some 60 days to go from the initial move higher in October to reach the panic highs at 35 on Christmas. The implosion has been even more furious. The VIX has gone from 35 to 18 in 10 trading days.
The move in European index vol, V2X, has been similar to the one we saw in VIX, but note the moves have been slightly less violent.
Gamma is the rate of change in an option’s delta per 1-point move in the asset’s price. It´s a significant measure of the options convexity with regards to the underlying asset. An options delta can be seen as the speed of the option, while gamma is the acceleration.
When bounces are furious, like the one we have been witnessing, the acceleration of the move can be huge, i.e. long gamma is a strategy that will benefit big (more reading on derivatives and options trading please click the links).
We suggested that bear markets (if this is a “real” bear remains to be seen) include shorter time periods of violent bounces, where the moves benefit the long gamma players. That´s why we suggested that Gamma is King in our recent post.
The entire market has bounced violently, but one of the biggest and most violent moves we have seen in large caps, is Netflix. It took the stock some 60 days to go from 350 to 240 ish. The bounce on the other hand has taken it from those lows at 240 straight back to 350 in 100 hours of trading.
That is why we love gamma!
Source: charts by Bloomberg