Trading Gamma Exposure: Revealing Our Favorite GEX Strategy
April 24, 2024
Let’s face it. In the realm of financial markets, where volatility reigns supreme and where dealers can dominate short-term market movements, finding a strategy that consistently outperforms the majority is no easy feat.
And unfortunately for most traders, success is elusive.
However, nestled within the complexities of markets lies a gem of a strategy: leveraging gamma exposure (‘GEX’) data. In this article, we’ll explore the principles behind gamma exposure-based trading and how it can potentially stand as a beacon of stability amidst market turbulence.
Understanding Gamma Exposure-Based Trading
At its core, gamma exposure-based trading revolves around understanding and exploiting the option market’s gamma risk. If you’re not familiar with the basic concepts of gamma exposure, you can find an article we authored on the subject here.
Gamma measures the rate of change of an option’s delta concerning changes in the underlying asset’s price.
Traders utilizing gamma exposure aim to capitalize on this sensitivity to price movements, particularly during periods of extreme volatility expansion and extreme volatility compression.
Unlike traditional trading strategies that rely solely on directional movements or technical indicators, gamma exposure-based trading focuses on a combination of market positioning and implied volatility itself as a primary driver of profits. This data-driven approach stands in stark contrast to most short-term “strategies” that many traders typically use.
By strategically positioning options contracts, a GEX based methodology can profit from rapid price swings based on where option dealers and other big players in the market are positioning themselves.
The above NFLX example highlights market participants concentrated at the 600 strike (8% higher than where price was currently trading at the time). Using this data we could assess a number of different option strategies that both target a potential move towards 600 and fit within the risk/reward profile of our portfolio.
The market can and does changes its mind pretty often (GEX is a reflection of market interest and price sensitivity, not a perfect crystal ball unfortunately), however we have found that using GEX data combined with an asymmetric risk-reward portfolio methodology can yield successful results. In the case of our NFLX example, price did eventually go on to tag the 600 level 2 weeks later.
The Advantages of Gamma Exposure-Based Trading
The allure of gamma exposure-based trading lies in its ability to thrive in both volatile market conditions and low-vol environments. While conventional strategies may falter amidst uncertainty, gamma exposure-based approaches can flourish, thanks to their flexibility and adaptability.
One of the key advantages of this strategy is the ability to determine whether or not the market is positioned for volatility expansion or volatility compression. By analyzing the total gamma exposure for the indices, we can also determine if the market overall is leaning bullish, bearish, or neutral.
Furthermore, because GEX is based on the options market, using this data for research allows us to focus on particular strike prices at specific points in time. Below is an analysis on GLD showing GEX concentrated at the 195 and 200 strikes in the 3/15/24 expiration.
By combining this strategy with various option structures (credit/debit spreads, iron condors, double diagonals, etc.) we can tailor option positions to achieve an asymmetric risk-reward profile in our portfolio. Essentially, we can target strike prices, at specific expiration dates, with the highest GEX concentrations using meticulously crafted option strategies.
Utilizing options allows traders to potentially achieve significant returns with minimal upfront capital. Thus, using options in combination with GEX-based strategies can offer built-in risk management mechanisms, allowing traders to limit potential losses while maximizing potential profits.
This approach to trading can provide versatility because traders can position their portfolio to potentially profit in different market outcomes by focusing on GEX data points for indices, ETFs, and individual stocks.
And having the potential to profit in multiple market scenarios is the true holy grail of trading (in our humble opinion).
TSLA Example
Analyzing GEX on specific stocks to see whether the market for an individual stock is positioned bullish, bearish or neutral is a key aspect of using a GEX-based trading strategy. For example, the SPY may have positive gamma exposure (think of a buy-the-dip market environment) while at the same time TSLA may have negative gamma exposure (higher potential volatility).
Based on this data, if our portfolio overall was positioned bullishly, we may decide to add a short or neutrally biased option strategy in TSLA into our portfolio mix. By structuring a low cost option trade in TSLA we have given our portfolio the potential to capture a very specific outcome based on the options market in TSLA itself, even while the rest of our portfolio is bullishly positioned (with hedges of course).
This was actually a scenario we encountered during the month of March 2024. An analysis of the GEX data suggested that the market was bullishly positioned.
But at the same time we noticed TSLA had been struggling and had large negative GEX concentrated between the 160–175 strikes, with very little positive GEX showing at higher strike prices. Market participants appeared to believe that TSLA would remain weak even in the face of market strength.
In our experience, analyzing GEX data on individual stocks and incorporating specific option strategies into our portfolio mix allows for greater resilience against unexpected market movements and enhances the overall robustness of the trading strategy.
Key Principles of Gamma Exposure-Based Trading
- Option Selection: Constructing a portfolio with a variety of different option strategies is paramount to success in GEX-based trading. A combination of option strategies such as credit spreads, debit spreads, diagonals, butterflies, etc. that target various GEX concentrations across ETFs and individual stocks can have the potential to enhance overall results. This methodology has the added benefit of potential profits in a wide variety of market outcomes, since not all stocks move in unison especially in the short-term.
- Risk Management: Despite its potential for high returns, GEX-based trading carries inherent risks. Traders must implement robust risk management strategies to protect against adverse market movements and mitigate potential losses. We often will hedge our portfolio with the aim of simultaneously accounting for upside, downside and/or range-bound market outcomes on a short-term basis.
- Dynamic Portfolio Hedging: Because GEX data changes in real-time, continuous monitoring and adjustment of positions are essential in GEX-based trading. Traders must be prepared to dynamically adjust their portfolios as GEX evolves in order to account for changes in the GEX concentration at their target strike price.
- Market Awareness: Successful GEX-based traders monitor total gamma levels in the major indices and index ETFs to understand if overall market positioning is shifting. By monitoring GEX in real-time, traders can identify potential opportunities and navigate market fluctuations with confidence.
In a world characterized by market volatility and uncertainty, GEX-based trading offers a compelling alternative to traditional short-term strategies. While success in gamma exposure-based trading requires skill, discipline, and market acumen, the potential rewards make it a strategy worth exploring for ambitious traders seeking to thrive in today’s dynamic market landscape.
If you’re interested in learning more about our GEX-based methodology, consider becoming a member at geeksoffinance.com.
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