Gamma exposure and inventory rebalancing

Part I ended with a dealer holding a hedged book and re-running that hedge as price moves. Gamma is what decides how often they must re-run it, and — crucially — in which direction.

Delta is how much the book moves per dollar of underlying. Gamma is how much that delta itself changes per dollar. A book with large gamma sees its hedge go stale quickly; a book with little gamma barely needs touching. The sign of that gamma flips the entire behaviour of the hedge.

Long gamma: hedging against the move

A dealer who is net long gamma — typically because they bought options from the market — gains delta as price rises and loses it as price falls. To stay flat they must sell into rallies and buy into dips.

That flow is counter-trend by construction. Every push up meets mechanical selling, every flush meets mechanical buying. The result is suppressed realised volatility: price ranges, moves get absorbed, breakouts fail. When people say "the market feels heavy but nothing happens", this is usually the regime they are in.

Short gamma: hedging with the move

A dealer who is net short gamma — the normal state when the public is buying options — has the mirror problem. As price rises their short calls gain delta against them, so they must buy. As price falls they must sell.

Now the hedging flow is pro-trend. Buying begets buying, selling begets selling, and moves that would have died extend instead. This is the engine behind a gamma squeeze to the upside, and behind the airless, accelerating flushes to the downside.

Gamma is concentrated, not spread out

Gamma is largest for options near the money and near expiry, and it collapses away from the strike. So dealer gamma is not a diffuse field — it sits in stacks at specific strikes, wherever open interest happens to be concentrated.

That is what gamma exposure by strike renders: the notional hedging flow implied at each level, signed by whether dealers are long or short it. Big positive bars mark levels that will be defended by counter-trend hedging; big negative bars mark levels where the hedge accelerates whatever is already happening.

The level where the aggregate flips sign is the gamma flip. Above it the market usually behaves as if it is being held; below it, as if the floor is greased. The same asset, the same day, two completely different regimes — separated by a price.

The cadence of rebalancing

Three things speed up the hedging clock. Proximity to a strike, since gamma peaks at the money. Time to expiry — the closer to settlement, the more violently delta swings between 0 and 1 across a strike, which is why expiry days feel mechanical. And size of open interest at that strike, which sets how much underlying each rebalance actually moves.

When all three line up — a heavy strike, close to expiry, with price sitting right on it — the hedging flow can dominate everything else trading that hour. That case has a name and a chapter of its own.