web analytics

r/Superstonk – Clearing up some things about options, and how it deals with the Variance Swaps DD.

Posted by u/Criand

0. Preface

Hello apes. I am not a financial advisor and I do not provide financial advice.

A few things need to be cleared up, since there’s some, uhh, chaos.

Options are extremely risky but it is not a demon-spawn that should be avoided like the plague. It is another tool at retail’s fingertips just like DRS / direct registration. If you don’t understand them, ignore the posts and do not participate in options.

But, the discussion should not be muted entirely just because a few people YOLO’d into deep OTM CALLs with 0 delta and lost their life savings. That is not the fault of options. That is the fault of their misunderstanding or greed of the play.

If anything, this can hopefully at least draw eyes back on the Variance Swaps DD which has oddly disappeared from discussion lately.

By fire be purged

1. Clearing Some Stuff Up

  • No, you should NOT sell shares to play with options. I was hoping that was implied. I don’t know how that idea spread around, but it is absolutely not something that should be done. It was a lack of foresight on my end to not state that immediately.

  • I did not imply to bet on weeklies or short-term option plays. The strikes that I posted were simply a reference to show how options effect hedging versus buying shares outright. In fact, I personally would NOT do short-term plays (expiring within the next few 8 weeks). If you’re trying to do short-term option plays, there’s a good chance you will get burned. Pickleman (

    Variance Swap Purchase by Citadel (per /u/zinko83 DD)

    The gist of the Variance Swap DD is that they’ve opened up Variance Swaps to bet on the volatility in the stock, and to use them as insurance against their short position. They then sell a replicating portfolio (it replicates the swap with options) into the market. Doing this hedges against the swap.

    Per /u/zinko83‘s findings, they’re hedging Variance Swaps every single week with the options chain available via option Vega. This is literally textbook spelled out that Variance Swaps are hedged via option Vega. In which they need to get exponentially more OI for the more OTM strikes due to Vega approaching zero.

    r/Superstonk - Clearing up some things about options, and how it deals with the Variance Swaps DD.

    Variance Vega Replicating Portfolio (per /u/zinko83 DD)

    In the above:

    • A) A perfect hedge. Perfect across all strikes. This cannot happen in the real world.

    • B) A non-ideal hedge. This occurs in constrained strike week options. Such as the week of November 26th. Notice how the highest PUT strike is $100 for November 26 expiration unlike the $0.5 strike for November 19th. The lower and upper bounds of (B) fall off, and it makes it so that the prices outside of the range is unhedged.

    • C) An ideal hedge. A distributed Replicating Portfolio across all strikes. The ramp up you see in the image above is basically the OI required, increasing more as the strikes go more OTM. This is due to the smaller Vega on each contract the further OTM the strikes go. Which leads to an exponential increase in OI required to create the Replicating Portfolio.

    This applies both to CALLs and PUTs. Where as things go more OTM for either option, the amount of Vega drops, so more contracts are required to hedge against that strike. Which then essentially leads to an exponential curve on both sides of the chain as things go further OTM, but distributed out among strikes to achieve the Replicating Portfolio shown as (C) in the above rather than wasting capital on every strike possible.

    That explains the Deep OTM PUTs we were seeing such as the $0.5 strike. If you take a look at January 21, 2022 options, there is an OI of 136,176 for the $0.5 strike PUT. The only reasonable explanation for that is that it is a hedge, and the Variance Swaps lines up perfectly with the data we’re seeing. In no way shape or form is someone betting that GME will go to $0.5 by January 21, 2022.

    Variance Swap hedging also explains those smooth exponential curves of options that we see every single week when people post “max pain”. They’re using the options chain to suppress volatility of the stock and they absolutely want to avoid volatility since their swaps print when volatility is contained. And the main way they avoid volatility is by pushing retail to avoid options since they’d be forced to delta hedge the CALLs (with delta close to 1) that are purchased.

    They can easily hedge with option Vega with strikes between $0.5 -> $900 around monthly options due to a wider chain, which achieves (C). This allows them to clamp down the stock to avoid it shooting upwards. But the week of November 26th, the option chain will be more constrained and they’ll be unable to fully hedge with option Vega for their Variance Swaps, leading to a situation of (B) in the above. Next week’s strikes for PUTs start at $100 rather than $0.5, for reference.

    If the variance swap DD is correct, they’ll be forced to start buying up CALLs next week to hedge, causing them to trade the underlying and unfortunately for them resulting in an increase the stock price.

    Additional information per /u/zinko83 himself:

    Next week [November 26th expiration], the risk they are hedging with the weeklies is the “tail risk”. The closest expiry weekly chains are the most efficient way to hedge tail risk.

    Does that mean they always use the most recent chain? No of course not, as always it’s weighted pros vs cons.

    Last week [November 12th expiration] was a good example of them not using that chain and skipping ahead to this weeks [November 19th expiration] more favorable one to hedge. Probably a bit more expensive due to theta, but the cost of that theta probably was cheaper than letting the price action the previous two weeks go on for another week causing more risk that might have to be internalized which puts a strain on the balance sheet.

    The following post by /u/MauerAstronaut also goes into depth about the explanation behind the option chain “max pain” curves we see each week if you want to read more:

    How Variance Swaps can explain OI in far OTM Puts and many other of the Weirdnesses that were observable this year. – /u/MauerAstronaut

    Speaking of /u/MauerAstronaut, he left a great comment which pretty much sums up the situation if you’re looking for more of a TLDR:

    I have made arguments against options in the past. This was mostly based on the fact that we had no clue what made the stock go up or down. However, researching variance swaps I came to the conclusion that demoting options might not be in the best interest of apes.

    This is not about gamma sQuEeZeS that options bulls came up with in the past. This is about the fact that retail staying out of options makes hedging short variance exposure cheaper, easier to model, the stock becomes easier to control (less actual volatility), and also that SHFs absolutely want MMs to diamond hand the short options (in synthetic forwards), if any, that they sold to them. Retail, and subsequently whales trading in the shadows, could fuck that up very easily by attacking at the right time.

    That said I don’t recommend anyone play options unless you have an idea what you are doing. We have an ape specimen on our Discord who shows us everyday what happens when you trade on sentiment instead of data; the Dollar symbols in their eyes turn into GUH real quick. But it is important to learn this shit, and labeling it FUD isn’t going to help anyone except the SHFs. (Also, there’s absolutely bullish ways of playing options that are very safe, like selling puts into high IV on a dip.) – Link

    Hopefully it’s a bit more clear on why I felt the need to post about options with the above. These guys are smart – go read their posts. It’s pretty much universally agreed with other apes I’ve talked to that smart options plays can demolish their Variance Swap hedging strategy, and it is why they’d push the anti-options narrative all this time:

    1. The DD around Variance Swaps is pretty solid, and it goes hand-in-hand with the futures cycles that we see every three months.

    2. Citadel is able to hedge to pin the stock around max pain and prevent it from exploding while they maintain an ideal hedge of their Variance Swaps. Some weeks, when they have a constrained options chain, they’re forced to induce volatility in the stock by trading the underling. This is because they’re forced to buy up CALLs themselves just like in January, March, June, August.

    3. By introducing smart option plays, their Variance Swap hedging can become difficult to fund and model. Not only this, but they also need to hedge delta against the CALLs that retail purchased. Meaning more shares for them to buy. Which then causes them to re-hedge their Variance Swaps, and so forth. It can become a snowball effect for them. BUT…. that is if the DD is correct. Research it for yourself. Don’t trust myself or others because I made some flashy post.

    3. Well, They’re Just Not Going To Hedge The CALLs

    I’ve seen this quoted a bit today and I honestly don’t see much truth in this. People are referencing the SEC report, so let’s dig that up and break it down:

    r/Superstonk - Clearing up some things about options, and how it deals with the Variance Swaps DD.

    SEC Report, Page 29

    1. They did not find evidence of a gamma squeeze per hedging against retail CALL option buys. However, pay attention to the wording. They are saying that it was not a gamma squeeze that caused the price action, but, it was something else. This does NOT imply that they weren’t hedging. In nowhere of this document does it state that they did not hedge.

    2. A minor gamma squeeze occurred due to retail increasing option trading volume substantially, and they hedged against them per “an influx of call option purchases, which causes market makers to hedge their writing of the call options by purchasing the underlying stock”. But this was so miniscule in comparison to the other driver of the January sneeze, that it was ruled out as a gamma squeeze being the cause.

    3. They state that the main driver was that market makers were buying CALLs rather than writing the CALL options. Hmmm. Suspect, right? What happens with their Variance Swaps that they have to hedge against when rebalancing? They have to buy CALL options! It wasn’t a gamma squeeze, but a Vanna/Volga Squeeze since they were hedging the Volatility Swaps and were forced to trade the underlying!

    On top of this, /u/zinko83 pointed out in the following that for the Market Makers who are in Variance Swaps, they MUST delta hedge at the end of every market close because they are short gamma via their replicating portfolio through options:

    r/Superstonk - Clearing up some things about options, and how it deals with the Variance Swaps DD.

    Effects of Variance Swap Hedging (per /u/zinko83)

    Particularly take note of the 2nd page. If they don’t delta hedge properly, every day on the close, then the counterparties of the Variance Swaps are going to come knocking. They can’t simply “not hedge” otherwise they will make no money on their trade. Delta hedging has to occur.

    4. Closing

    Go read section #1 again. Don’t mess with options if you don’t know what you’re doing.

    And if you think you know what you’re doing, go read all of the DD again. Don’t enter this space if you aren’t absolutely sure on what you’re doing. Your confidence better be through the roof.

    The main reason I posted about options is because of how solid the Variance Swap DD is, and the supporting evidence around it. It’s pretty damning because it explains why they’d try to avoid retail catching on to options plays, which can mess with their hedge bets and catch them red handed.

    Don’t sell your shares to play options.

    DRS is and always will be the way. Stick to it no matter what. Not financial advice.

    Options are not taboo. Let those who understand them discuss them. If you don’t understand them, ignore the posts.

    Hedgies R fuk.