Dealer Gamma Exposure

Think of a market maker's hedging book as a shock absorber bolted under a car. Depending on how it's tuned, a bump in the road either gets smoothed out or gets amplified into a bigger jolt. Dealer gamma exposure ("GEX") is an attempt to read, from the outside, which way that shock absorber is currently tuned — because it changes how the whole market behaves when prices move.

Why dealers hedge at all

A dealer who sells a customer a call option is short gamma: as the stock rises, the dealer's delta grows more negative and they must buy stock to stay hedged; as it falls, they must sell. A dealer who instead buys an option from a customer is long gamma and does the opposite — sell into rallies, buy into dips. Aggregated across every strike and expiry, the sign of the total tells you which way dealer hedging flow will lean.

The formula, defined in words

$$\text{GEX} = \sum_i \text{OI}_i \times \Gamma_i \times 100 \times S^2 \times 0.01$$

Here $\text{OI}_i$ is the open interest at strike $i$ — how many contracts are outstanding — and $\Gamma_i$ is that option's gamma, how fast its delta changes per $1 move in the underlying. The $100$ converts contracts to shares, $S^2$ rescales gamma into dollar terms per 1% move, and the sign is flipped for puts under the standard convention (dealers assumed short the calls and long the puts customers trade). In plain terms: multiply contracts outstanding by sensitivity by the underlying's dollar size and add it up — the result estimates how many dollars of stock dealers must trade for every 1% the index moves.

Worked example 1 — positive GEX and a calming market

Suppose dealers are net short 10,000 call contracts at a strike near the current price of a $500 index, each with gamma 0.01, under a convention where this makes dealers long gamma overall (customers are heavy sellers of calls against long stock). If the index rises 1%, or $5, dealer delta shifts by $10{,}000 \times 100 \times 0.01 \times 5 = 50{,}000$ shares' worth in the direction that requires selling into the rally to stay hedged — a stabilizing flow, what "positive GEX" describes.

Worked example 2 — negative GEX and an amplifying market

Now flip it: dealers are net short gamma overall — common during sell-offs, when customers buy puts for protection and dealers sell that protection. Using the same 10,000-contract, 0.01-gamma numbers, a 1% drop forces dealers to hedge by selling roughly 50,000 shares' worth of stock — selling into a falling market, the mechanism widely blamed for accelerating drops like the one in February 2018.

What this means in practice

Traders watch GEX estimates, published by several data vendors from options open interest, as a proxy for expected realized volatility: strongly positive GEX has historically coincided with grinding, low-volatility markets, while strongly negative GEX regimes tend to see sharper swings. It is used as a rough regime filter, not a standalone trading signal.

Practice

1. Dealers are short 5,000 put contracts at a $100 strike, gamma 0.02, and this makes them net short gamma. If the underlying falls 2% ($2), roughly how many shares' worth must dealers sell to rehedge?
2. Why would GEX flipping from positive to negative as spot crosses a big open-interest strike matter more to traders than the absolute GEX level far from that strike?