Net Gamma Exposure (NGE) and its effect on stock prices has been an active research topic recently. Reference [1] applied this concept to the Chinese stock market, studying the NGE effect on intraday stock direction and the relationship between futures and options.
Specifically, the paper presents evidence supporting the idea that market makers’ trading activities are a driving force behind the significant reversal effects observed in China’s futures and options markets. The first test provides direct evidence from the perspective of gamma hedging, the second test examines the effects from the viewpoint of vega hedging, and the third test explores the responsibility of Chinese market makers to provide liquidity. The authors pointed out,
Based on the 1-min high-frequency data of China’s commodity futures and options market from 2017 to 2022, this article examines the intraday momentum effect of China’s commodity futures and options. The research of this article found that China’s options and futures markets have significant intraday reversal effects, and that the overnight and opening factors (ONFH) and intraday factors (ROD) can predict the market’s return in the last half hour (LH). Comparing the overnight opening factor (ONFH) and the intraday factor (ROD), this article finds that most of the time (futures, call options), the intraday factor is a better predictor, but for put options, the predictive ability of the overnight opening factor is more significant…
More importantly, this article provides three novel evidence that links market intraday reversal with market makers’ trading behavior. We first explore the Gamma exposure, and find that negative gamma will lead to a stronger intraday reversal effect. Then, we test the prediction between futures’ volatility with option price, and point out that the Vega Hedge demand is one of the sources of the cross-effect between futures and options. Thirdly, this article tests the liquidity to intraday reversal effect. Chinese market makers tend to close accumulated positions when liquidity is high. We divide the sample into a high liquidity group and a low liquidity group. The regression results show that when the market liquidity is sufficient, China’s commodity futures and commodity options show a significant intraday reversal effect; when the market liquidity is lacking, show a significant intraday trend effect.
In short, similar to the US counterpart, NGE, which is caused by market makers, leads to a strong intraday reversal effect. Interestingly, the demand for vega hedging is also identified as one of the sources of the cross-effect between futures and options.
We note, however, that since market makers’ positions are not publicly available, daily options open interest was used as a proxy to estimate the market makers’ NGE.
Let us know what you think in the comments below or in the discussion forum.
References
[1] L. Zheng and X. Luo, Is there an intraday reversal effect in commodity futures and options? Evidence from the Chinese market, Pacific-Basin Finance Journal 88 (2024) 102534
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