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Understanding charm flows from the options market

Happy Tuesday, Traderade family! We've been getting a lot of questions about the options market on our Discord lately, so I wanted to write an article to address a concept that is often discussed as another installment in a series of educational articles about options.

What is charm?

In options trading, charm (also known as delta decay) is a second-order Greek that measures the rate of change of an option's delta with respect to the passage of time, assuming all other factors remain constant.

Delta is the first-order Greek that measures the sensitivity of an option's price to a change in the underlying asset's price. In other words, charm helps traders understand how the option's delta will change as time goes by.

Charm is particularly important for options market makers, professional traders, and institutional investors who actively manage their portfolios and hedge their positions. As the option's expiration date approaches, charm can have a more significant effect on the option's delta, requiring more frequent adjustments to hedge the position's delta exposure.

When do charm flows tend to occur during the month?

Charm flows generally increase as the monthly options expiration approaches. Charm, also known as delta decay, is the rate at which an option's delta changes with respect to the passage of time. As options approach their expiration dates, their charm tends to become more significant due to the time decay accelerating.

This means that the rate at which the delta changes increases, causing option market makers and other professional traders to adjust their portfolios more frequently to hedge their delta exposure.

As a result, charm-adjusted trading flows, or charm flows, tend to increase as options approach expiration, leading to higher trading activity in the underlying securities, such as stocks or indices like the S&P 500 Index (SPX). This increased trading activity can create market dynamics that impact asset prices, liquidity, and volatility.

When do charm flows tend to happen during the US trading day?

Charm flows can vary throughout the trading day depending on a variety of factors, including market events, liquidity, and investor behavior. However, there are certain times during the trading day when charm flows might be more intense in the S&P 500 Index (SPX).

Generally, charm flows may be more pronounced during the following periods:

  1. Market open: Trading activity is usually higher in the first 30 minutes to an hour after the market opens. This is when traders are adjusting their positions based on overnight news, pre-market activity, and opening price gaps. Charm flows can be intense during this period as market participants re-balance their portfolios and hedge their delta exposure.

  2. Market close: The last hour of trading, and especially the last 30 minutes, can see increased charm flows as traders and institutional investors adjust their positions and hedge their portfolios before the market closes. This can lead to higher trading volumes and potential price fluctuations.

What factors impact charm flows?

How charm influences the price of the underlying asset will depend on whether there is a skew within the distribution of premium, and the significance of that skew.

For example, a strong skew towards puts would promote charm flows that would be buying the underlying asset. A neutral skew would mean charm flow impacts on price discovery would be muted. A skew towards calls is more likely to promote selling of the underlying asset as market makers manage their delta hedging in light of decay.

It's important to remember that charm flows can be influenced by various factors and can change from day to day or even within the same day. Additionally, market conditions and behavior by participants, such as market makers and traders, can evolve over time and sometimes rather rapidly, so past trends might not necessarily predict future charm flow patterns.

Always consult the latest market data available and consider the current market environment when analyzing charm flows or making trading decisions. Remember that all trading comes with risk, and that risk may be greater than your vested capital if you are trading with leverage.


Mayhem, Love your Clear and concise style!

Markets & Mayhem
Markets & Mayhem
Apr 21, 2023
Replying to

Thank you!

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