Read the Map · Lesson 5 of 9
Who’s on the Other Side: Dealer Hedging
When you trade an option, a dealer usually takes the other side and hedges with shares. Follow one hedge step by step and see why that hedging can calm a move or push it further.
In this lesson
- Explain what a dealer does and why it hedges instead of betting on direction
- Work through a delta hedge step by step with share counts
- Describe why long-gamma hedging leans against moves and short-gamma hedging chases them
- State the assumption behind the StratosHedge map and why it makes the map an estimate
Every option trade has two sides. When you buy a call, someone sells it to you, and usually that someone is a dealer. Dealers quote a bid and an ask all day and aim to earn the small gap between them. They don’t want to bet on which way the stock goes. So a dealer usually places a hedge on its overall position: an offsetting trade, usually in shares, so a move up or down roughly cancels out.
Delta tells you how much an option’s price changes for a $1 move in the stock. A call with a 0.50 delta gains about $0.50 per share, or $50 per contract, if the stock rises $1. For a dealer, delta doubles as a hedge ratio. Being short 10 calls at 0.50 delta behaves like being short 10 × 100 × 0.50 = 500 shares, so buying 500 shares cancels it out. That’s delta hedging.
One hedge, step by step
A customer buys 10 calls
SPY trades at $598. A customer buys 10 of the $598 calls, each with a 0.50 delta. The dealer who sold them is now short calls, which acts like being short 500 shares.
The dealer hedges
The dealer buys 500 SPY shares, about $299,000 worth. Now small moves cancel out: what it loses on the calls, it makes on the shares, and the other way around.
Price rises $2
SPY climbs to $600. Gamma, the rate at which delta changes, lifts the calls’ delta to about 0.60. The short calls now act like short 600 shares, but the dealer owns only 500. To stay hedged, it buys 100 more shares while price is rising.
Price falls back
SPY slips back to $598 and delta returns to about 0.50. Now the dealer owns 100 shares too many, so it sells 100 while price is falling.
Because the customer bought the options, the dealer ended up short gamma, and its hedging bought as price rose and sold as price fell. That trades in the same direction as the move and can push it further. Now flip the trade. Suppose a customer sells calls, as many investors do against shares they own. The dealer buys those calls and is long gamma. Long calls gain delta as price rises, so the dealer sells shares into the rally to stay neutral, then buys them back on the dip. That hedging leans against the move and can calm it down.
Dealer short gamma
- Buys shares as price rises
- Sells shares as price falls
- Hedging can add to moves
- Linked to the Volatile regime you’ll meet two lessons from now
Dealer long gamma
- Sells shares as price rises
- Buys shares as price falls
- Hedging can dampen moves
- Linked to the Calm regime
One dealer buying 100 shares is nothing. But dealers hedge positions across many strikes and millions of contracts, and they adjust all day. When a lot of positioning sits near the current price, especially close to expiration when gamma is largest, that hedging can be large next to normal trading. It’s one force among many: news, big funds and everyday buyers and sellers often matter more. But it’s mechanical. Dealers don’t need an opinion to do it, which is why it’s worth mapping.
Example From hedging to a dollar number
StratosHedge estimates each strike’s gamma exposure as gamma × open interest × 100 × spot price. Say SPY is at $600 and one strike has a gamma of 0.04 with 50,000 contracts of open interest. That’s 0.04 × 50,000 × 100 = 200,000 shares per $1 move, or about $120 million of stock at $600 a share, if dealers held all of that open interest on one side, as the model assumes. That’s one strike. The map adds up every strike near price.
Watch out The big assumption
Dealers’ actual positions aren’t public. StratosHedge assumes dealers are net long calls and net short puts, because many investors sell calls against stock they own and buy puts for protection. So calls count as positive gamma and puts as negative. In the model, the short-gamma side comes from puts: dealers are assumed short puts, so their hedging sells into declines. This dealer-side sign assumption is a model choice, not observed data. When customers heavily buy calls or sell puts, the map can mislabel levels or the regime.
Check your understanding
5 questions. Answer each one, then open “Show answer” to compare.
Question 1 of 5 A dealer is short 5 calls with a delta of 0.40. About how many shares does it buy to be delta-neutral?
sharesShow answer
Answer: 200 shares.
Each contract covers 100 shares, so 5 × 100 × 0.40 = 200. Owning 200 shares offsets the short calls’ delta, so a small move up or down roughly cancels out.
Show answer
Answer: B. Sell shares into the rally, leaning against it
Long calls gain delta as price rises, so the dealer’s position leans long. To get back to neutral, it sells shares, which leans against the rally. That’s long-gamma hedging, the kind that tends to dampen moves.
Show answer
Answer: False.
Hedging is mechanical. A dealer adjusts its shares to stay neutral as delta changes, whatever it thinks about direction. That’s why the flows can be estimated from positioning at all.
Question 4 of 5 Put this short-gamma hedging sequence in order. Put these in order, first to last.
- The dealer buys shares to offset the short calls’ delta
- The dealer buys more shares while price is rising
- Price rises and the calls’ delta increases
- A customer buys calls and the dealer sells them
Show answer
Correct order:
- A customer buys calls and the dealer sells them
- The dealer buys shares to offset the short calls’ delta
- Price rises and the calls’ delta increases
- The dealer buys more shares while price is rising
The dealer starts short calls, hedges with shares, then has to buy more as gamma raises delta. Buying into a rise is what makes short-gamma hedging add to moves.
Show answer
Answers: A. Calls are counted as positive gamma · B. Puts are counted as negative gamma · D. It can be wrong when customers heavily buy calls or sell puts
The map assumes dealers are net long calls and net short puts. Real dealer inventory isn’t public, so this is a model choice. When customer behavior runs the other way in size, the estimate can mislead.
Key takeaways
- Dealers hedge so they aren’t betting on direction, and delta tells them how many shares to hold.
- Gamma changes delta as price moves, so the hedge needs constant adjusting.
- Long-gamma hedging leans against moves; short-gamma hedging chases them.
- The StratosHedge map rests on an assumption about who holds what, so treat it as an estimate.
Try it in StratosHedge
Open SPY in Key Levels and look at the gamma profile. Find the strike with the largest positive bar and the one with the most negative bar. For each, ask: if price moved toward it, which way would the modeled hedging lean? (Under the model, positive bars lean against the move and negative bars go with it.)
See the gamma profile Needs: Retail plan
Key terms
- Dealer (market maker)
- A firm that quotes bids and asks and takes the other side of customer trades, then hedges so it isn’t betting on direction.
- Hedge
- A position taken to offset risk in another position, such as buying a put to protect shares you own.
- Delta
- How much an option’s price changes for a $1 move in the underlying. A 0.50 delta call gains about $0.50 per share ($50 per contract) on a $1 rise.
- Delta hedging
- Trading the underlying to cancel an option position’s delta. A dealer short one 0.40-delta call buys about 40 shares to stay neutral.
- Gamma
- How fast delta changes for a $1 move in the underlying. It’s largest for at-the-money options close to expiration.
- Gamma exposure (GEX)
- An estimate of how many dollars of stock dealers may need to trade for each $1 move, per strike and in total, based on open interest.
- Open interest (OI)
- The number of option contracts still open at a strike, not yet closed, exercised or expired. It’s published once a day.
- Dealer-side sign assumption
- The model’s assumption that dealers are net long calls and net short puts, so calls count as positive gamma and puts as negative.
- Gamma profile
- A chart of estimated gamma exposure at each strike, showing where positive and negative gamma cluster around price.
Sources and further reading
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Educational content, not investment advice. Lessons describe how markets and models tend to behave. They don’t tell anyone what to buy, sell or hold. Interactive examples use illustrative sample data, and simulator results are simulated — not actual trading. Options involve risk and are not suitable for all investors.
Risk disclosureCharacteristics and Risks of Standardized Options (OCC) (opens in a new tab)