Short Gamma: The Market-Maker Spiral

Description and use

Short‑gamma dealer positions mechanically amplify sell‑offs, turning normal price drops into larger crashes.

Problem

Market makers’ short‑gamma positions mechanically amplify sell‑offs, turning normal price drops into larger crashes.

Outcome

The simulation shows that short‑gamma dealer positions can amplify a 5% market drop from ~12% to ~15% drawdown, confirming that mechanical selling is a significant risk factor.

Workflow

• 1. Measure VIX and SKEW to gauge market calm and tail protection cost.
• 2. Infer dealer net gamma from SKEW percentile (high SKEW → short gamma).
• 3. Run dealer_gamma.py simulation to compute amplification of a price shock.
• 4. Compare baseline (no dealer gamma) to short‑gamma scenario.
• 5. Optionally model intervention at –6% to assess dampening effect.

Evidence

SKEW is a shadow of dealer positioning. When SKEW is high, clients have paid up for tail protection, which means the dealer's net position is more short gamma.

Source

Running it with the actual September 7 market state: Net dealer gamma –0.67 (from SKEW 83rd percentile) → amplification 3.07× → about –15.4%.

Source

The model estimates net dealer gamma at –0.67 — not an extreme reading, just “tail protection is expensive” — and the amplification is already there.

Source