This is from an exchange in the Global-View Help Forum:
tor pumpkin 18:30 GMT October 20, 2008
Grahma, sorry for the slow reponse.
You are correct, options are relevant to spot, but it is only part of the picture, and you need to know a lot of the various parts or else make a lot of assumptions in order to complete the picture. I have cut and paste something I wrote for Jay several years ago. (And yes I feel rather dated seeing “2002” behind that post).
tor Pumpkin 17:32 GMT January 25, 2002
Gamma is the second derivative of the option price w.r.t. spot.
It defines what a market maker has to do in the spot market as spot fluctuates (to manage his/her delta position).
If we are long gamma (which usually means long vol, i.e. long an option), as spot goes lower we buy, and as spot goes higher we sell: so buy low, sell high. This dampens the move (lowers volatility).
If we are short gamma (short vol / short an option), we buy as it goes higher, sell as it goes lower. Buying into the highs, selling into the lows causes exaggerations of spot moves.
This effect is especially noticeable if the option being hedged is short dated.
So it’s important to know how the market makers are positions as one can count on them to dynamically delta hedge rather predictably. What we don’t know is whether the client is delta hedging. Is the client another market maker? Is the client a corporate hedger? In which case, it’s highly unlikely they will delta hedge. Is the client a hedge fund or SWF who does delta hedge? Possibly, not always, sometimes religiously.
So your cut/paste about EURCHF is somewhat useless to me (as it doesn’t say how market makers are positioned). Your example about GBP vols are of no importance to spot. It is merely stating the level of vols.
Typically I use the strike comments as “something to tuck in the back of my head” but rarely trade off it
And yes, ATM is always ATM forward.
London Graham 13:40 GMT October 17, 2008
I'd like to ask a question regards Option info in relation to Spot prices if I may?
I know what an option is, but I don't really know how to use the data or even if it’s worthy of note for retail purposes?
What influence do option expiries and strikes have on the movement of spot prices?
Should I expect price to move towards or away from strike as we approach expiry time (usually NY cut) & should/could it influence orders/trades I'm looking to make?
am example of said info:
"FX OPTIONS: EUR/CHF Large 1.5270/75 expiries today. A cumulatively estimated EU1bn of 1.5270 and 1.5275 strikes reportedly roll off at today’s 10am Eastern NY cut"
Am I to assume EUR/CHF is going to move towards 1.5270/75? or maybe away from it (so as not to hit strike price)?
What about something like the following:
"FX OPTIONS: GBP/USD 6-mth ATMF Vol Firms, Now Pivoting 14.9% . 6-mth ATMF vol is currently indicated at 14.75/15.1, having been 14.5/14.9 at today’s London open."
I'm sure this is valuable information; I just don't know how to use it or even read it? Can you help?
- I believe ATMF means "at-the-money forward"?
- I trade spot, not options. But I believe this options info is there for some reason relevant to spot trading, or am I wrong?