Structure, Process, and The Options Order Book
In ‘The Implied Order Book,’ a white paper by @SqueezeMetrics, crash risk is explained as a function of how many investors have sold puts. Quoting the research, “Sold puts are, quite literally, a bunch of huge buy limit orders below the market…”
So, based on last week’s trading in $SPX puts … those that marked at or below bid … puts in regular monthlys … out to end-of-year 2022 … with lot sizes ≥ 10 and transaction sizes ≥ $1M … we can plot the amount of premium at stake … at price levels below market. This could provide us some general feel for where price might encounter high liquidity, should a big order displace the market … moving the auction vertically … with conviction … out of balance … a dislocation of inventory. From out of balance the market moves to balance … pausing to re-define fairest price.
Integrating options data and the auction market process emphasizes the intimate relationship they share. Thursday and Friday saw two days of balance. Should the market break below the auction bracket low (ABL) … to the downside … with a concomitant increase in volatility … the premium associated with those sold puts becomes important … as they, along with neighboring market stop loss orders, increase crash risk. And in a negative GEX environment, increases in implied volatility make GEX less significant and other liquidity taking factors take precedent.
Auction market theory submits that “initiating” breaks outside the balance area rarely fully retrace and commonly trade towards the next level of high liquidity.
Those key reference levels can be seen by plotting their values … and are illustrated in the chart above.