Markets have entered negative gamma – buckle up
Dealers are forced being to buy rallies and sell dips, increasing volatility. That should serve as a warning. Although markets currently appear calm and resilient, beneath the surface they are becoming more fragile, says Helen Thomas
Markets are entering a profoundly unstable moment for the global price of risk. The supply shock emanating from the Strait of Hormuz threatens to further disequilibrate an already strained global system. Even before geopolitical tensions reignited energy markets, the AI revolution was creating enormous bottlenecks. Semiconductor supply chains were already constrained, with concerns mounting that chipmakers could not expand capacity quickly enough to satisfy demand. Now rising energy prices and the prospect of outright shortages have introduced an even more intractable problem.
Yet financial markets have become increasingly detached from these fundamental realities. The US stock markets merrily print fresh record highs even as global bond yields also soar while underlying global economic activity faces deep physical challenges. Markets are almost metaphysical now, driven as much by the mechanics of derivatives trading as by traditional assessments of economic probability.
Since last year’s “Liberation Day” reversal, when Donald Trump abruptly paused tariffs after markets plunged, investors have internalised one dominant behavioural mantra: Don’t Get Caught Short.
That shift has transformed market psychology. It is no longer simply about keeping some cash on the sidelines for protection, or even merely outperforming peers. Investors fear being left behind altogether. The result has been not only a breathtaking rally in stock prices, but also an explosion in the gamma exposure embedded within the market itself.
And where the spot market goes, volatility trading follows.
Time is part of the trade
Options trading is now so vast and liquid that the behaviour of derivatives traders exerts an outsized influence on the underlying market. In the world of options, it is not just direction that matters, but speed. Time itself is part of the trade.
This means options traders must constantly rebalance their positions, even when nothing particularly dramatic is happening. Sometimes they are positioned to benefit from calm markets, mechanically buying small dips and selling small rallies in order to maintain hedges. If these traders dominate daily flows, the effect can be self-reinforcing: volatility compresses, trading ranges narrow, and markets appear eerily stable.
To outsiders, the language of options trading can seem impenetrable. Traders speak in Greek letters: delta, gamma, theta and countless others. But the basic intuition is simpler than it sounds.
Delta measures how much an option’s price changes when the underlying asset moves. Gamma measures the rate of change of delta itself.
Think of it like a game of whack-a-mole. When markets move and one risk exposure pops up, traders must immediately hammer it back down with another trade to restore balance. If you know the overall positioning of options traders, you can begin to anticipate whether markets are likely to encounter systematic buyers on dips or systematic sellers into rallies.
When markets are in what traders call “positive gamma”, dealers tend to buy falling markets and sell rising ones. This dampens volatility and stabilises price action.
But the opposite can also occur.
In a “negative gamma” regime, dealers are forced to buy rallies and sell dips instead, amplifying market moves rather than suppressing them. Selling begets more selling. Momentum feeds on itself.
The S&P 500 entered such a negative gamma zone around the end of March as tensions in the Strait of Hormuz worsened. The resulting dealer hedging flows contributed to the acceleration lower in equities and the spike in volatility.
But markets have since staged a violent reversal following the US-Iran ceasefire. What had been a vicious cycle became a virtuous one. The VIX index collapsed, the S&P 500 surged higher, and gamma exposure flipped back into a more benign positive configuration.
If this feels dizzying, that’s because it is.
The speed of the transition from negative to positive gamma has been among the fastest seen in five years. The rate of change of the rate of change has itself become extreme. The last comparable period of such violent shifts was during the pandemic.
That should serve as a warning. Although markets currently appear calm and resilient, beneath the surface they are becoming more fragile.
As the US equity market sits at the centre of the global financial system, volatility in the S&P 500 increasingly transmits itself across asset classes worldwide. Bond markets, currencies, commodities and even emerging markets are all influenced by the same volatility ecosystem.
That is why everyone should be watching this week’s earnings release from Nvidia on Wednesday. It is no longer simply another technology company. It has become both the emblem of the AI boom and a geopolitical bellwether for US-China relations. By virtue of its sheer market capitalisation, Nvidia is also deeply embedded in the architecture of volatility trading itself. When Nvidia moves, the effects cascade through options markets, index hedging flows and volatility products globally.
The recent violent swings in gamma therefore matter far beyond Wall Street. The speed of these reversals points to a market structure that is becoming increasingly unstable beneath the surface, even as equities continue to rally higher. Against a backdrop of geopolitical tension, energy insecurity and stagflationary pressure, instability in US volatility markets will not remain contained to American equities. It will ripple across the global financial system.
Helen Thomas is founder and CEO of Blonde Money