Monthly and especially quarterly options expiration (OPEX) are major events in the market, often associated with common patterns and short-term turning points.
Options expiration is classified into two types: Call-weighted, also known as positive gamma, meaning more calls are set to expire than puts; and Put-weighted, also known as negative gamma, meaning more puts are set to expire than calls.
To determine whether the market is call or put-weighted, refer to both the Expiration Concentration chart and the Gamma Index within the Daily Market Report.
Call-Weighted Cycle
During OPEX week, the market typically exhibits a positive or flat trend. This is because the elevated and growing positive gamma from the calls supports the market, leading dealers to buy dips and sell rips in large quantities. Therefore, the natural course is for the market to hold up, and implied volatility to compress.
Post OPEX, the market typically loses a percentage of positive gamma, around 20-40%. This reduction weakens support and resistance levels and unpins volatility. Essentially, post OPEX, the gamma landscape undergoes a 'reset' as participants reposition and establish new levels.
This period is generally known as a 'window of weakness', where the most common pattern is for the market to consolidate or pull back in the week following OPEX. However, this pattern does not occur every time, and the relationship often breaks down in Q4 if participants lack upside exposure, leading them to continue to bid on calls to obtain convexity and prevent underperformance into year-end.
Day-to-day, we monitor whether the Gamma Index is strengthening or weakening. If the market continues to rise and the Gamma Index increases in the final week, this could shift the Call Wall and ABS higher, as gamma is highest for at-the-money options. A 'risk-off' signal is indicated by a break below the Flip and a spike in volatility.
Put-Weighted Cycle
During OPEX week, the market typically exhibits elevated volatility. This is because the growing negative gamma from the puts destabilizes the market, prompting dealers to sell dips and buy rips, which exacerbates price movements in both directions.
Post OPEX, the market then sheds a percentage of its negative gamma, resulting in an initial increase in the Gamma Index, indicating the market is beginning to stabilize. As market gamma declines, volatility decreases, further contributing to market stabilization.
This period is generally known as a 'window of strength', where the most common pattern is for the market to move higher, often via a squeeze. However, this pattern does not occur every time. If fear persists in the market, participants may be inclined to bid on puts, quickly pushing the Gamma Index deeper into negative territory. A 'risk on' indication occurs with a break above the Flip and a drop in volatility.