Lesson 3 of 8 · 2 min
Dealer hedging
Why market makers hedge their option books in the underlying, and how that can feed back into price.
Who dealers are
Dealers (market makers) take the other side of customers' options trades. Their business is earning the spread, not betting on direction, so they hedge the directional risk of their option positions — commonly by trading the underlying futures or stocks.
Delta hedging
If a dealer is short calls, they're exposed to a rise in price. To neutralise that, they buy some of the underlying. As price moves, the option's delta changes (that's gamma), so the hedge must be adjusted — continuously.
Why it can matter for futures
- If dealers' hedge adjustments mean buying as price rises and selling as it falls, hedging can amplify moves.
- If adjustments mean selling into rises and buying into dips, hedging can dampen moves.
Which one applies depends on whether dealers are net long or net short gamma — covered next.
Uncertainty
Nobody outside the dealers sees their actual books. Public models assume which side of each trade dealers are on. Those assumptions can be wrong.
Trading implication
Treat hedging-flow ideas as context for volatility — a reason a day might be calmer or more volatile — rather than a directional signal.
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