The trading industry has always been shaped by trends. Over the decade preceding the original 2024 article, those trends seemed to develop faster and more intensely. Around 2015, CoT data drew enormous attention, and everyone wanted to trade like Larry Williams. Then volume trading became more popular, and traders searched for the holy grail in the Volume Profile. In the years before the article, “order flow” dominated the conversation.

In 2024, another term gained ground in trading forums: dealer hedgingDealer hedging means managing risk from options positions held by a dealer.. We cannot offer a strategy with a 100 percent hit rate here either. Understanding the subject can, however, help you interpret possible hedging zones in the market. Data and objective information can help you form an informed view alongside your own experience as a trader. They cannot predict the next price move with certainty.

In professional day trading, we always want to answer two questions: “Where?” and “What?” The “where” defines the price areas in which a trade might be considered at all. When price reaches such an area, we watch order flow to assess particular events. The market tells a story, and the skill lies in reading and interpreting it. Combining “where” and “what” helps us examine possible trade ideas; it does not create a certain trade.

If we understand why market makersMarket makers quote buying and selling prices and thereby contribute to market liquidity. hedge their risks in options markets, we can use that mechanism to identify possible price areas to watch. It does not tell us with certainty whether dealers will trade there or whether an opportunity will arise. Market makers are institutional participants who provide liquidity to markets. Their task is to help buyers and sellers find a counterparty without a long delay.

Market makers may earn money through compensation for providing liquidity and by trading the spread. For example, they may buy at the bid and sell at the ask, sometimes using very fast algorithms. Such methods can be a form of high frequency trading (HFT), but market making and HFT are not the same thing. Retail traders generally do not have comparable technical infrastructure.

In his dealer hedging course, Oliver compares market makers with the joker in a deck of cards. The metaphor describes their role as a possible counterparty; it does not mean a dealer can choose the next market price at will.

Options dealers have hedged in similar ways for decades, but the term dealer hedging has gained popularity only in more recent years as options markets have grown. As those markets have grown, hedging activity has become more relevant as a subject of market analysis.

Market makers’ actions can affect the underlying markets. The size of that effect on a particular day depends on their actual net positions and market liquidity. High options volume does not establish a fixed share of total S&P 500 turnover. For day traders, understanding the mechanism can be one part of market analysis; it does not produce a price prediction.

Market makers provide market liquidity. When a trader places a market sell order, ideally a limit buyer should be available on the other side quickly so that the trade can be completed efficiently.

In highly liquid markets, this is relatively straightforward. It becomes harder in less actively traded securities and in options markets, where hundreds of strikes and expiry dates divide trading interest among many contracts. Market makers provide counterparties in those markets as well, helping you execute a trade promptly. But they cannot always offset the resulting risk immediately with a trade in the very same optionAn option gives its buyer a time-limited right to buy or sell an underlying asset in exchange for a premium..

If no suitable counterparty is available, a dealer may retain an open position in its book. To reduce the risk, the dealer may, for example, buy or sell the option’s underlyingThe underlying is the asset on which an option is based, such as a stock or a future.. Depending on the option, that can be a stock or a future. The amount actually hedged also depends on the other positions in the dealer’s book.

Suppose you own Apple shares and want to protect them against falling prices. You buy put options. The market maker selling you those puts now has directional risk: the position benefits if Apple rises and loses value if Apple falls.

To hedge, the dealer may sell Apple shares in a proportion related to the short put’s deltaDelta describes how sensitive an option’s price is to a move in the underlying asset.. This stock hedge gains value when Apple falls and loses value when its price rises. Trading in the underlying market may offset part of the dealer’s risk. How much the trade affects Apple’s price depends on the dealer’s net position and market conditions.

In this simplified Apple example, a stock sale may offset part of the risk from a short put option.

The more options trades market makers hold in their books, the more risk they may need to hedge in the underlying assets. More significantly, existing hedges may need repeated adjustment under certain circumstances, leading to further buying or selling. The direction and size of those adjustments depend on the entire book.

That activity can have a substantial effect on the underlying price, but it does not always do so. High trading volume in S&P 500 options alone does not show how much dealers need to hedge on a net basis. What matters is the buying and selling exposure left in their books after positions are offset, and the size of a possible hedge relative to liquidity in the underlying market.

This possible influence explains why day traders may want to understand the subject. A suspected hedging zone is a reason to observe the actual market reaction, not an entry signal on its own.

Delta describes an option’s current sensitivity to a move in the underlying. GammaGamma describes how delta changes when the underlying asset’s price moves. describes how much delta changes. When price moves, an existing hedge may become too small or too large. The dealer may then adjust it through further purchases or sales.

The direction is not always the same. With a positive net gamma position, hedging can work against a price move; with a negative net gamma position, it can move with it. The dealers’ net position, rather than gross visible options volume, matters for potential market impact.

A Cboe study of short-dated SPX options illustrates this difference between gross volume and net risk. Its findings concern the market and period studied; they do not provide a universal figure for all dealer hedging.

Dealer hedging activity can affect markets. For day traders, it is therefore useful to understand the mechanism and consider possible trading locations as part of market analysis. Understanding how market makers operate can help you watch price areas where hedging might become relevant. It does not show with certainty whether dealers will act there.

Public options data cannot tell us in advance exactly where market makers must buy or sell a stock or future. Nor can they establish whether a breakout or reversal is more likely at that price. A possible hedging area only becomes meaningful alongside the observed price reaction and the wider trading context.

Understanding dealer hedging can help us develop possible swing and day trading ideas and examine them against our own setup. It cannot reliably predict the next price direction. Price area, order flow, market reaction and risk management therefore belong together.

If you want to learn the mechanism yourself, the dealer hedging course takes you from options basics to calculating possible hedging areas. The course is currently offered in German. Level of Interest shows calculated price areas in your chart; whether you trade them depends on your own rules and the market’s reaction.