Knopf theory to explain volatility in the equity market

In recent months the stock market has become curious to use a technical term. This is further below the general bumptius instability at the top of a bull market.

Markets jump wild and crash into impossible names such as pun from junk stock Gamestop It was at established companies like Viacom CBS after Archagos was dragged to defeat.

One of the factors in many episodes of Wonder Market is the shadow of the equity options market.

The volume of equity option adoption has increased in recent years. According to the NYSE, the average Daily volume Trading transactions in alternative contracts in equity and exchange trade funds increased from 17.5 million in 2019 to 27.7 million in 2020. This year the market is in motion for more than 40 million contracts.

This is important for those who still trade in the boring old plain-vanilla stock market because all options for buying and selling shares have to be hedged by their dealers who offer them.

For the “call” option of buying stock, dealers often do this by buying underlying shares. In Jargon, the amount of shares a dealer has to buy in order to hedge an alternative to a dealer is the “delta” of the option. Delta depends on the strike price of the option and how the stock could be hit on the expiration date of the option.

The complex part here. An alternative delta changes with the price of the underlying stock. So if a stock really starts to move, options dealers will have to buy more of it to hedge the options they sell. This adds to the upward price pressure, drives the stocks more and forces dealers to buy more stocks, which in turn. . . Okay, you can see where this is going. This was the kind of snowball Back Inside the more violent spike Gamestop, A name retail piles buyers heavy piles.

The punchline is that at any given moment the market condition of the equity options will tell you something about the pressure that will be felt in the equity market itself later on – and it should be possible to trade on this fact.

The rather impossible standard bearer for this type of business is Lily Francis, some twenty-one PhD student at Bioinformatics. Until recently, he was an amateur businessman, but his fun and interesting Social media And blogs Post She has won a media presence, and is now making a living.

Francis’ main idea is an indicator called Knopp – the “net option pricing effect” – which is fairly ready and (or as he puts it, “hand-wave”) the gauge market for the weight that the stock is carrying in the alternative market. It assumes that the amount of liquidity available in a particular stock or index is hedging of the alternative seller (this is just a guess, because dealers have other ways to hedge than buying shares). The stock is calculated as the delta of all outstanding “call” options, with the total daily volume of shares trading divided by the delta of all “put” options divided by trading.

When the knop goes abnormally high, Francis says, “there is a trend against the market”. His explanation is that since a stock is moving fast and alternative traders go into it to make sure it has been hedged, this makes the rally final. But when the assembly finally exhausts itself, the option dealers drop all purchases at once and the market returns quickly.

Lily Francis says “measure-related behavior” began in the market in 2018

“When volumes related to options are a significant part of the market, it makes the market volatile,” he concludes. Keeping an eye on the NAP can, theoretically, help you choose which rallies to sell (this seems to work for the Routes as well, but not reliably).

This volatile-encouraging character of options is a great repetition of a familiar Wall Street embarrassment: a financial instrument designed to manage risk makes the market risky The spec credit default and the swap of total returns are two better examples.

The increase in volume and size of alternatives in recent years also shows the protein nature of the risk. When it is pressed in one area, it appears elsewhere.

Francis noted that “knop-related behavior” began in the market after Credit Suisse in 2018 Off Its huge XIV funds, which provided traders a way to bet on market volatility. Funds were crushed on a market route earlier this year, “he said.VolmagdenHowever, traders are leaning towards market volatility: the traditional therapeutic, highly profitable way for the equity options market.

Along with Napa, Francis has crystallized an idea that could give us a deeper understanding of market volatility. However, risk levels remain high, especially in bull markets.

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