Diving Into Gamma-Weighted SOIR as a Bullish Indicator

Stocks with high gamma-weighted SOIR tend to outperform

Senior Quantitative Analyst
Jun 9, 2021 at 8:55 AM
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    One of our better-known indicators is the Schaeffer’s Open Interest Ratio (SOIR). The SOIR only considers open interest in the front three expiration months, and is the number of puts divided by calls. Drilling down on this, we also consider the gamma-weighted SOIR, in which we weight the open interest depending on the option’s gamma. Below, I will go over why we do this, and show the power of using gamma-weighted SOIR as an indicator. Then, I will leave you with a list of stocks to consider for short-term trades.

    What Is Gamma?

    Since this is not meant to be an article on option Greeks, I will only briefly describe gamma, and how it is relevant to our indicator. The Greeks are used to quantify how sensitive an option is to certain variables. Delta is a number that describes how sensitive the option price is to changes in the underlying asset price, while gamma tells an option trader how much the delta will change.

    To understand why we use gamma, just look at the chart below, which shows an option’s gamma depending on its strike price. An option that is at-the-money (ATM) has a very high gamma. The farther the strike price is from the stock price, the smaller the gamma.

    For the gamma-weighted SOIR, we multiply the option’s gamma by its put open interest, and then we multiply it by the option’s call open interest. Dividing the gamma-weighted puts by the gamma-weighted calls gets us the gamma-weighted SOIR. This indicator gives higher importance to open interest that is near-the-money, and disregards open interest that is either deep in-the-money, or deep out-of-the-money.

    IOTW 1

    Theory Behind the Indicator

    High gamma options are relevant for a couple of reasons. First, options with strikes near-the-money have generally been recently added and convey the latest sentiment towards a stock. A high amount of puts on a stock suggests pessimism, which we believe has bullish implications.

    The second reason has to do with the mechanics of market making. When a trader buys put options on a stock, the market maker who sells the puts becomes exposed to a drop in the stock price. Therefore, he shorts a certain amount of stock as a hedge, determined by the delta of the puts he sold. If the stock rises, it makes his put options less likely of being in-the-money and decreases his chances of having to pay out money at expiration. As the stock price goes up, he covers his short position, which is a further tailwind for the stock. In other words, we would expect a high gamma-weighted SOIR to be a bullish indicator.

    Reliable Indicators for Gamma-Weighted SOIRs

    To test this indicator, I looked back at S&P 500 Index (SPX) stocks throughout the past year, or 52 weeks. Each week, I found the stock returns from Monday’s open to Friday’s close based on the stock’s gamma-weighted SOIR, calculated using that Friday’s expiration date (and meeting some liquidity criteria). I grouped the 25 stocks with the highest gamma-weighted SOIRs, as well as the 25 stocks with the lowest gamma-weighted SOIRs and summarized their returns. 

    As you will see below, this indicator has an impressive track record. The table shows the stocks with the highest gamma-weighted SOIRs each week averaged a gain of 1.55%, with 56% of the stocks beating the S&P 500 that week. The stocks with a low gamma-weighted SOIR reading at the beginning of the week averaged a slight loss of 0.28%, with only 42% able to beat the S&P 500.

    IOTW 2

    25 S&P 500 Stocks With Highest Gamma-Weighted SOIRs

    As promised, here are some stocks to consider based off the analysis above. The first table consists of the 25 S&P 500 stocks that have the highest gamma-weighted SOIR based on next Friday’s expiration. According to this study, they have a better chance of outperforming. 

    IOTW 3

    Lastly, here is the list of stocks with the lowest gamma-weighted SOIR. Over the past year, the stocks with a low reading usually underperformed.



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