A number of things happened this week:
The week started with a huge delta exposure to rising share price due to a huge open interest in call options (particularly relative to a limited effective free float of investors willing to sell).
People likely increased this call position on Monday triggering share price rise from market makers buying shares to hedge the new options they sold.
This created a delta hedge spiral higher.
While this was happening investors began rolling $ exposure into contracts with lower delta (to keep more leverage and upside potential).
This all continued on Tuesday, except average delta of all options got too high (above 80%) with the vast majority of options deep in the money. This meant the delta feedback from higher prices faded because delta cannot go above 1.
Put option bets increased on Monday but jumped dramatically on Tuesday. Possibly this was all timed by hedge funds (including Citron) to happen at a similar time late in trading which caused the sudden 10% drop (because option market makers who sold puts had to sell shares to delta hedge their position). Some of the increase in put options may have been longs hedging their downside however (and in the process crashing their own shares).
On Wednesday the downside feedback loop had momentum and with the large put options position there was a lot of delta hedging requirement for market makers to sell shares as the price increased.
Right now the market's exposure to the options delta hedging feedback loop is higher than ever. So there is a reasonable chance +-20% days continue. With the direction possibly started by small catalysts such as headlines or people put on or taking off call option or put option bets.
Call Option Open Interest Changes This Week:
View attachment 508500
Put Options Open Interest Changes this week:
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Net Call minus Put Options Open Interest Trends this week:
View attachment 508502
All these numbers assume 100% of option sellers delta hedge their shares and 100% of option buyers do not (and no not own positions in underlying shares).
This is not the case in reality for several reasons, but these numbers should still be valid directionally whether you assume 50% or 80% of the net delta exposure of the market needs delta hedging.
Reasons why an option may not be delta hedge:
- Market maker to market maker open options for hedging do not have to be delta hedged. If one market maker open a call contract with another market maker to delta hedge some of their other open Tesla call options, then this amplifies the open interest in the market but does not increase net delta exposure of the market. However I doubt this is a huge % of open contracts as a huge book of long and short open call contracts between market makers purely for the purposes of hedging is a very inefficient market. If they did put on option hedges with other market makers they would be incentivised for it to be exactly the same contract, so they don’t end up with a huge book of open contracts with other market makers with different vega, theta exposures etc. In this case, the option market open interest would be reduced by this transaction. The liquidity of the Tesla option market actually makes this more likely given most delta exposure is in liquid contracts where it is easy for market makers to close.
- Options sold for covered calls,
- Call/put spread trades
- Unhedged options sold by investors etc.
