Gamma Squeezing: An analysis of the market impact of institutional equity options market makers on the underlying market

Abstract

With the increase in retail investors expressing opinions on companies through equity options during the peak of COVID-19 activity, as perhaps best illustrated by increasing activity on forums such as the Reddit community wallstreetbets, derivatives exchanges have increased the frequency with which equity options expire. For instance, Tesla options have weekly expiries, the Russell and Nasdaq indices have expiries on Mondays, Wednesdays, and Fridays, and the S&P has daily expiries. Consequently, it is of great interest to people who participate in equities markets to understand how option expiry affects equity price movement. This thesis aims to demonstrate that as a result of institutional options market makers hedging out their risk to the price of the underlying asset, equity prices with options either experience large moves or virtually no move in the last few hours of the afternoon on the day of expiry. One well-studied specific instance of this phenomenon is pinning, where on the day of expiry, the equity price tends to close very near some option strike price. Outside of being interesting for those who wish to participate in equities trading, such a result offers one possible refutation to the efficient market hypothesis, since such a price movement in equities is not reflective of any information or sentiment about the company, but rather an expression of the risk aversion of certain market participants in a correlated product.