Market Intraday Momentum and Hedging Demand

Day trading is a trading strategy whereby traders aim to take advantage of small price movements in the market. To do this, they buy and sell securities within the same day. Day traders typically use technical, quantitative, or sentiment analysis to make decisions about when to buy and sell.  There are a number of different day trading strategies that traders can use. Some common strategies include momentum trading, mean reversion, and trend following.

Momentum trading is a strategy that seeks to take advantage of upward price momentum. This type of trading relies on the belief that prices tend to move in the same direction once they have started moving. Momentum traders look for stocks that are moving up and try to ride the momentum by buying the stock and selling it later at a higher price.

Reference [1] examined how gamma exposure affects the market intraday momentum.

More importantly, we identify a novel economic force that drives market intraday momentum: market participants’ hedging demand coming from short gamma exposure. Our tests link both cross-sectional and time-series variation in market intraday momentum to such hedging demand. Our evidence suggests that concentrated trades of groups of investors – like portfolio insurers, option market makers and leveraged ETFs – can have substantial, non-fundamental price impact, amplifying price changes and impacting market dynamics around the times they trade. Paradoxically, these dynamics may even lead to leveraged (including short) ETFs to underperform their underlying index, as the hedging impact of their trades tend to revert. At the same time, market dynamics are strongly predictable intraday, and as such, proactive investors can benefit, for example by providing liquidity opportunistically in anticipation of hedging flows, or a smart timing of planned trades.

In short, market intraday momentum is linked to hedging demand coming from short gamma exposure. These dynamics are predictable, and as such, proactive investors can benefit from them.

In a previous post, we discussed how market makers net gamma positions affect the VIX-SPX lead-lag relationship.  The present article [1] contributes to a small number of papers that study how options gamma exposure affects market dynamics.

References

[1] Baltussen, Guido and Da, Zhi and Lammers, Sten and Martens, Martin, Hedging Demand and Market Intraday Momentum (2021). Journal of Financial Economics (JFE), Volume 142, Issue 1, October 2021, Pages 377-403

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