Month end delta buyback

Delta buyback at the end of the month refers to a phenomenon where market participants, particularly institutional investors and market makers, adjust their hedges for options positions as the month comes to a close. This adjustment often involves buying back delta, which can influence the price of the underlying asset. Here's a detailed explanation:

Key Concepts

1. Delta: Delta is one of the Greeks used in options trading and measures the sensitivity of an option's price to changes in the price of the underlying asset. For example, a delta of 0.5 means the option's price will change by $0.50 for every $1 move in the underlying asset.

2. Hedging: Market makers and institutional investors often hedge their options positions to remain delta-neutral, meaning they don't have exposure to the directional risk of the underlying asset. They do this by buying or selling the underlying asset to offset the delta of their options positions.

3. Options Expiration: As options approach expiration, their delta changes more rapidly (gamma increases). This requires more frequent and significant adjustments to hedges.

What Happens at the End of the Month

1. Vanna and Charm Flows:

   • Vanna: Vanna refers to the change in delta with respect to changes in implied volatility. As volatility changes, the delta of options changes, requiring adjustments to hedges.
   • Charm: Charm (or delta decay) refers to the change in delta over time, even if the price of the underlying asset and implied volatility remain constant.

2. End-of-Month Adjustments: Towards the end of the month, institutional investors and market makers often need to rebalance their portfolios and hedges. This is due to the convergence of vanna and charm effects, where the delta of options changes as time passes and as implied volatility shifts.

3. Delta Buyback: As these participants adjust their hedges, they may need to buy back delta, which involves buying the underlying asset. This buying activity can provide upward pressure on the price of the underlying asset.

Why Delta Buyback Occurs

1. Expiration-Centric Activity: Options expiration dates often cluster around the end of the month, particularly for monthly and weekly options. As options approach expiration, the need for precise delta hedging increases.

2. Rebalancing Portfolios: Institutional investors often rebalance their portfolios at the end of the month to align with their investment mandates or strategies. This rebalancing can include adjusting delta exposures from options positions.

3. Hedge Adjustments: Market makers who are short options need to adjust their hedges as the month progresses, especially as options move closer to expiration. If they are short calls, for example, they need to buy the underlying asset as the delta of the calls increases.

Impact on the Market

1. Price Movements: The cumulative effect of delta buyback can create noticeable buying pressure in the underlying asset, leading to price increases. This effect is often more pronounced in less liquid markets or in individual stocks with significant options activity.

2. Volatility: End-of-month delta buyback can also affect market volatility. As market makers and institutional investors adjust their positions, the increased trading activity can lead to short-term volatility spikes.

Example

Suppose there is a significant amount of open interest in call options for a major stock, and these options are nearing expiration at the end of the month. If the stock has moved closer to the strike price of these call options, the delta of these options will increase. Market makers who are short these call options will need to buy the underlying stock to hedge their positions as the delta increases—this is the delta buyback. This buying pressure can push the stock price higher as the month closes.

Conclusion

Delta buyback at the end of the month is a phenomenon driven by the need for institutional investors and market makers to adjust their delta hedges as options approach expiration. This often involves buying the underlying asset, leading to upward price pressure. Understanding this dynamic can provide traders with insights into potential end-of-month price movements and volatility changes.

Original Twitter post by Cem

Friday May 31, 2024
5m SPX chart with but back flow