Key Levels and Key Terms

🏦 The Option Market and Market Makers

In this post you will find a definition of the Menthor Q Key Levels as well as Key Terms in Options Trading.

Key Levels

1D Exp Move %: Menthor Q’s proprietary indicator utilizes historical implied volatility to predict the price range movement, which is then presented as a percentage change from the previous day’s closing price. The range is expressed in Min and Max number or Low and High Expected Move for the day.

1D Exp Move Max: This is the maximum daily expected move for the day based on Menthor Q’s proprietary indicator 1D Exp Move %.

1D Exp Move Min: This is the minimum daily expected move for the day based on Menthor Q’s proprietary indicator 1D Exp Move %.

Gamma Condition: this field tells you if the market is in positive or negative gamma. Positive gamma comes with low price volatility. When the market is in negative gamma one expects higher price intraday volatility.

Vol Regime IV/HV: the index describes the current volatility regime. There are two categories to describe this regime:

Positive: in this scenario implied volatility is greater than historical volatility
Negative: in this scenario implied volatility is lower than historical volatility

Call Resistance: this is the price level with the most net gamma when it comes to calls. Generally this is the level with the most upward resistance. A shift upward of this level can be bullish for the market. It is represented by the green dotted line. We are looking at data from All Expirations in the option chain.

Call Resistance 0DTE: this is the price level with the most net gamma when it comes to calls with an expiry of 24 hours or less.

Put Support: this the price level with most net gamma when it comes to puts. Generally this is the level with the most downward support. A shift downward of this level can be bearish for the market. It is represented by the red dotted line. We are looking at data from All Expirations in the option chain.

Put Support 0DTE: this is the price level with the most net gamma when it comes to puts with an expiry of 24 hours or less.

High Vol Level (HVL): this is a key level. When the market is above this level we are in a positive gamma environment. Below it we move into a negative gamma environment. This level is usually found between the Call Resistance and the Put Support level. We expect realized volatility to move higher as spot price breaks below this level.

GEX Levels 0 to 10: they represent the Secondary Levels. These are shown as GEX Level 0 to 10 and represent the Levels with the highest Net GEX and DEX that are within the 1D Exp Range. For Example GEX Level 0 will be the level with the highest Net GEX and DEX within the 1D Exp Move Max and Min, GEX Level 2 will be the third level with the highest Net GEX and DEX within the 1D Exp Move Max and Min and so on.

Greeks:

Delta: Delta measures the sensitivity of an option’s price to changes in the price of the underlying asset. It quantifies how much the option’s price will change for a $1 change in the price of the underlying asset. Delta is an important concept for understanding how options behave and for implementing strategies like delta hedging. Delta is expressed as a value between -1 and 1 for individual options, and it has different interpretations depending on whether the option is a call option or a put option. The delta of a call option ranges from 0 to 1 while the delta of a put option ranges from -1 to 0. Delta values are not static; they change as the price of the underlying asset changes. Furthermore, delta values are influenced by other factors like time to expiration, implied volatility, and interest rates. As the option approaches expiration, the delta of an option “in the money” tends to move closer to 1 (for calls) or -1 (for puts), while the delta of an option “out of the money” tends to move closer to 0.

Gamma: Gamma measures the rate of change of an option’s delta in response to changes in the price of the underlying asset. In simpler terms, gamma tells you how much the delta of an option will change for a $1 change in the price of the underlying asset. It provides insight into how sensitive an option’s delta is to price movements of the underlying asset. Gamma is expressed as a positive value and is represented as a percentage or a decimal. It’s particularly important for traders who engage in strategies that involve managing delta, such as delta hedging. When an option’s gamma is high, changes in the underlying asset’s price can lead to frequent adjustments in the hedging portfolio to maintain a delta-neutral position.

Vega: Vega measures an option’s sensitivity to changes in implied volatility. Implied volatility reflects the market’s expectations for future price fluctuations of the underlying asset. Vega indicates how much an option’s price will change for a 1% change in the implied volatility of the underlying asset.

Theta: Theta measures the rate at which the value of an option decreases as time passes. It represents how much an option’s price will change due to the passage of one day, all other factors being equal. Theta is particularly important for understanding the impact of time on the value of an option. Theta is always negative for options. Theta is affected by implied volatility. Higher implied volatility tends to increase an option’s extrinsic value, which in turn can slow down the rate of time decay (lower theta). Conversely, lower implied volatility can speed up time decay (higher theta).

Rho: Rho measures an option’s sensitivity to changes in interest rates. It indicates how much an option’s price will change for a 1% change in the risk-free interest rate.

Vanna: Vanna is a second-order option Greek that measures the sensitivity of an option’s delta to changes in the volatility of the underlying asset. In other words, vanna quantifies how the delta of an option changes in response to changes in both the price of the underlying asset and changes in implied volatility. Vanna provides insights into the interaction between delta and volatility. It’s a measure of the change in an option’s sensitivity to price movements when volatility changes. Vanna can be positive or negative. Positive Vanna indicates that when the underlying asset’s price rises and volatility increases, the option’s delta becomes more positive (more sensitive to price changes). Negative Vanna indicates the opposite scenario, where the option’s delta becomes less positive (less sensitive to price changes) as volatility rises.

Charm: Charm, or delta decay, is the rate at which the delta of an option or warrant changes with respect to time. Charm refers to the second order derivative of an option’s value, once to time and once to delta. It is also the derivative of theta, which measures the time decay of an option’s value. Charm provides insights into how an option’s delta is affected by small changes in the underlying asset’s price. Charm can be positive or negative.

Other Key Terms

Call Option: A call option is a financial derivative contract that gives the holder (the buyer) the right, but not the obligation, to buy a specific quantity of an underlying asset at a predetermined price, known as the “strike price,” within a specified period of time, until the option’s expiration date. In exchange for this right, the buyer pays the seller (the writer) of the option a premium upfront.

Put Option: A put option is a financial derivative contract that gives the holder (the buyer) the right, but not the obligation, to sell a specific quantity of an underlying asset at a predetermined price, known as the “strike price,” within a specified period of time, until the option’s expiration date. In exchange for this right, the buyer pays the seller (the writer) of the option a premium upfront.

Moneyness (ITM, ATM, OTM): Option moneyness refers to the relationship between the current price of the underlying asset and the strike price of an option. It helps describe the potential profitability of the option based on the current market conditions. Moneyness is a classification that helps traders and investors understand the intrinsic value of an option and its likelihood of being exercised. There are three main categories of option moneyness:

In the Money (ITM): An option is considered “in the money” when the option’s strike price is favorable compared to the current market price of the underlying asset. For call options, an ITM option has a strike price lower than the current market price of the underlying asset. For put options, an ITM option has a strike price higher than the current market price. In other words, there is already intrinsic value in the option. ITM options typically have higher premiums because they have a higher likelihood of being exercised.
At the Money (ATM): An option is considered “at the money” when the option’s strike price is very close to the current market price of the underlying asset.
Out of the Money (OTM): An option is considered “out of the money” when the option’s strike price is not favorable compared to the current market price of the underlying asset. For call options, an OTM option has a strike price higher than the current market price. For put options, an OTM option has a strike price lower than the current market price. OTM options have no intrinsic value and are composed entirely of time value. They have lower premiums and are considered riskier since they require a larger price move in the underlying asset to become profitable.

Historical Volatility: Historical volatility is a measure of the actual volatility of an underlying asset over a specific period of time, calculated as the standard deviation of the daily price returns of the asset over that period. It provides a historical perspective on the level of volatility the underlying asset has experienced in the past. A high historical volatility suggests that the underlying asset has experienced large price movements in the past, while a low historical volatility indicates that the underlying asset has experienced relatively stable price movements. A spike in Historical Volatility could mean short term market stress is imminent.

Implied Volatility: Implied volatility is a measure of the market’s expectation of future volatility of an underlying asset, as reflected in the prices of options contracts. It is calculated using an options pricing model, such as the Black-Scholes model, which takes into account factors such as the strike price, time to expiration, and current market price of the underlying asset. A high implied volatility suggests that the market expects the underlying asset to experience large price movements in the future, while a low implied volatility indicates that the market expects the underlying asset to experience relatively stable price movements.

Volume: Total volumes refer to the total number contracts traded in a particular market the day before. Volumes are a key metric used to measure the level of activity and liquidity in a market. High trading volumes are generally associated with high liquidity and indicate that there is a lot of interest and activity in a particular security or market. Low trading volumes, on the other hand, can indicate a lack of interest or uncertainty among investors.

Call Volume: Total Call volumes refer to the total volumes of calls traded the day before.

Put Volume: This indicates the total put volumes traded the day before.

Open Interest: Open interest refers to the total number of outstanding contracts or positions that have not been closed or delivered on a particular future or options contract. Open interest represents the total number of contracts or positions that are still “open” or “unsettled” at the end of a trading day. For example, if there are 100 contracts of a certain commodity futures contract that have been bought but not yet sold, and 50 contracts that have been sold but not yet bought, then the open interest for that contract would be 150.

Call Open Interest: this is the open interest for call options.

Put Open Interest: this is the open interest for put options.

Market Maker: Market makers are entities or individuals that provide liquidity to the market by constantly quoting buy and sell prices for various financial instruments, including options. Their goal is to profit from the bid-ask spread and transaction volume while managing the risks associated with market movements.

Bid/Ask Spread: Market makers earn their profit from the difference between the bid price (the price at which they’re willing to buy) and the ask price (the price at which they’re willing to sell). They aim to buy at a lower price and sell at a higher price, capturing the spread.

Delta Hedging: Delta hedging is a risk management strategy commonly used in finance, particularly in options trading, to minimize or eliminate the risk associated with changes in the price of the underlying asset. The “delta” in delta hedging refers to the delta of an option. Delta measures the sensitivity of an option’s price to changes in the price of the underlying asset. Market makers often use delta hedging to manage the risks associated with changes in the underlying asset’s price. When a market maker receives an order to buy or sell an option, they immediately calculate the delta of that option. They then adjust their position in the underlying asset to make the overall delta of their portfolio neutral. This means that they are offsetting the directional risk caused by price changes in the underlying asset. Since market makers are constantly receiving new orders and market prices are constantly changing, they need to adjust their portfolio frequently to maintain a delta-neutral position. If they don’t adjust their positions promptly, they could be exposed to significant risk if the market moves against them. Delta hedging is a fundamental practice for market makers, as it allows them to provide liquidity to the market while minimizing the impact of market movements on their profits.

Total GEX: This is the total volume of Gamma Exposure (GEX) per strike.

Net GEX: The Net GEX is the net gamma exposure, which is calculated by subtracting put gamma from call gamma for the underlying. It is an important metric for evaluating the level of realized volatility in the market. A positive Net GEX is indicative of lower volatility. This is because if the market maker is long Net GEX, they are able to decrease realized volatility by delta hedging. The market maker would go short when the market surges and go long when it declines, thereby reducing volatility. However, if the Net GEX is negative, the opposite effect is observed. In such cases, the market maker shorts the market when it drops and goes long when it surges, which amplifies the market movements.

Total DEX: This is the total volume of Delta Exposure (DEX) per strike.

Net DEX: Net DEX is the net delta exposure, which is computed by subtracting call delta from put delta, similar to the process of calculating net GEX. The primary purpose of calculating the net delta is to determine whether the market maker has a long or short delta position, which has implications for market liquidity and price movements. The market maker needs to go long or short on the underlying asset to be delta-neutral as they delta-hedge their positions.

Gamma Expirations: this is the total notional of gamma expiring on a specific date. Big expirations can lead to technical movements in the market as participants re-hedge and re-position.

IV Rank: IV Rank, is used to compare the current implied volatility to its historical implied volatility over a specific period of time. It is a way to assess whether the current implied volatility is high or low compared to its historical levels. It is expressed as a percentage and is calculated by taking the current implied volatility and comparing it to the range of implied volatility values that the option has traded at in the past. The range is typically defined as the highest and lowest implied volatility levels over a specific period of time, such as the past year. For example, if IV Rank is 100%, this means the IV is at its highest level over the past 1-year. An IV rank of 80% means that the current implied volatility (IV) of an asset is higher than 80% of its historical IV readings over a specified period of time, and lower than only 20% of them.

IV Percentile: IV percentile, compares the current implied volatility of an option to its historical implied volatility over a specific period of time. It expresses the current implied volatility level as a percentage of its historical implied volatility distribution, rather than as a ranking within that distribution. It is calculated by first creating a distribution of implied volatility levels for the option over a specific period of time. This distribution is then used to determine where the current implied volatility level falls within that distribution. While IV rank compares present IV to both high and low volatility levels over the past 252 days; IV percentile tells us the percentage of days over the last year when IV was lower than its present level.

Distance to HVL %: this field represents the distance in % of the Spot Price to the High Vol Level.

GEX Put/Call Ratio: This is the ratio of the total GEX per call vis a vis total GEX per puts.

DEX Put/Call Ratio: This is the ratio of the total DEX per call vis a vis total DEX per puts.

OI Put/Call Ratio: The Put/Call Ratio Open Interest is a measure that compares the open interest of put options to the call options open interest. Open interest refers to the total number of outstanding contracts that have not been closed or delivered.

Volume Put/Call Ratio: it represents the ratio of volumes between calls and puts.

Positive Gamma: When the market is “in positive gamma,” it means that the overall gamma of the market is positive. In positive gamma we tend to see lower volatility.

Negative Gamma: When the market is “in negative gamma,” it means that the overall gamma of a portfolio of options positions is negative. In negative gamma we tend to see higher volatility.

OPEX: “OpEx” in options trading refers to “options expiration,” which is the date on which options contracts expire and become invalid if not exercised. OpEx is a crucial event for traders and investors who hold options positions, as it marks the end of the contract’s lifespan and can lead to various outcomes depending on the option’s moneyness and the holder’s decisions.

Monthly Expirations: Options on many securities, such as stocks and exchange-traded funds (ETFs), have standardized monthly expiration dates. These monthly expirations usually fall on the third Friday of the month. Additionally, some securities have “weekly options” with expirations every week. This allows traders to select expiration dates that align with their trading strategies.

DTE: this is the time or days to expiry. For example if you take 1, that would represent the 0DTE row or 1 day to expiration.

0DTE: “0DTE” stands for “Zero Days to Expiration,” and it refers to options contracts that are set to expire on the same day they are traded. These are very short-term options contracts with no time remaining until expiration.

SPX Options Tickers: If you trade SPX Options you need to be aware that the options trade using two tickers: SPX and SPXW. SPX are monthly expirations while SPXW are daily and weekly options.

Top 10 Positive GEX & DEX Strikes: represent the 10 strike prices with most positive GEX and DEX.

Top 10 Negative GEX & DEX Strikes: represent the 10 strike prices with most negative GEX and DEX.

Term Structure: The term structure in options trading refers to the relationship between the maturities (expiration dates) of different options contracts and their corresponding implied volatilities. Similar to the yield curve in the bond market, the options term structure provides insights into market expectations about future volatility levels and can impact trading strategies and decisions.

Skew: Options Skew, also known as volatility skew, refers to the uneven distribution of implied volatility levels across different strike prices of options with the same expiration date. It is a graphical representation of how implied volatility varies based on the moneyness (distance from the current market price) of the options. There are two main types of volatility skew:

Put Skew: This occurs when the implied volatility of OTM put options is higher than that of OTM call options. Put skew often indicates that market participants are more concerned about potential downside moves in the underlying asset.
Call Skew: This occurs when the implied volatility of OTM call options is higher than that of OTM put options. Call skew suggests that traders are more focused on potential upside price movements.

Risk Reversal: A “25D Risk Reversal” refers to a specific options trading strategy involving the combination of a long out-of-the-money (OTM) call option and a short out-of-the-money put option, both of which are 25 delta options. In this context, the term “25D” refers to the delta of the options used in the strategy.