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Wizard of Ops Articles

Swing Trading Analysis Framework

5/29/2023

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Swing trading is a style of trading that involves holding an asset for an intermediate time frame of one day to several weeks in order to profit from price movement, or "swings".

These are the core principles and assumptions underlying the swing trading framework with Volland. These principles are realistic and have shown to be true with our own observations and discussions with MMs. Under these principles will be their rationales.
 
Principle #1:
Dealers need to be fully hedged by the end of the day. This is also true in 0DTE.
  • Dealer deltas at the beginning of the day are already hedged. Since dealer deltas are fully hedged, the delta chart on Volland is only good to help guide conversations about how customers are positioned (through the inverse of Volland data).
  • Dealers hedge their vega positions, but not as fully as their delta positions. While dealer deltas have a clear and easily measurable hedge, it is not as clear with vega. In SPX, vega is hedged with other options, /VX futures, and skew-adjusted deltas on their individual models. It is impossible at this point to track counterparties and dealer positioning in those areas, so Volland at this point assumes 85% of vega is hedged. This is a conservative estimate and extends to vanna as well.
  • Exercise of options are net neutral. While dealers may release /ES hedges from an excessive delta position that expires, they are typically already prepared for it through other options and 0DTE trading. Our informal studies of expiring delta positions in SPX have shown no correlation to opening price the next day.
 
Principle #2:
Dealers hedge to deltas, not PnL. The PnL follows the delta hedging; therefore, dealer delta, vega, and theta are not the greeks to focus on. Gamma, vanna, and charm are. Dealers do have to report their aggregate vega and theta positioning, but they tend to be hedged through /VX futures and other options. On the 0DTE timeframe, they tend to hedge using other options to have dynamic hedging in premium.
 
Principle #3:
The 2nd order greek with the most impact is the one with the highest notional hedging.
  • Gamma, Charm, and vanna notional (15% on SPX) account for all delta hedging in existing positions. As a result, this formula for existing positions is assumed to be true: 
    •     (Gamma Exposure * Underlying Change)
    • + (Aggregate Vanna * Fixed Price Vol Change) 
    • + (Aggregate Charm Exposure * Number of Hours Passed)
    • = Total Delta Notional Hedged
  • When there are new trades applied during the day, those deltas will be accounted for by dealers. However, the existing positioning is the primary concern for swing trading. Note: we have changed charm to be an hourly measure from a daily measure.
  • Gamma, vanna, and charm exposure change at the end of the day will be hedged - not at the beginning. The less markets move, the more trivial this principle is, but there could be some changes to existing dealer positioning between your last update during regular trading hours and the actual dealer needs. Because of this principle, you need to be able to predict the changes in the notional value based on the behavior of the Greek, the strike it is on, and the total notional at that strike.
  • The ratio of each 2nd order Greek’s notional hedging to the total affects its impact on dealer hedging. If you read a gamma chart perfectly and it has little effect, it could be because vanna impact is far higher. The y-axis will show you the impact of each of these 2nd order greeks is most impactful to dealer hedging.
 
Principle #4:
Dealers account for 35-40% of all underlying movements. This was based on a discussion with the CBOE data team. While dealer hedging accounts for a majority of the underlying movement, there are other traders, including passive investors, hedge funds, stock traders, fundamental traders, technical traders, CTAs, ETF rebalancers, funds, and many other participants, Volland is only dealing with option dealer hedging requirements. Those other traders may oppose Volland, and it may not be a perfect match all the time. Volland shows just one piece of the market movement puzzle – a significant one. 
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