Futures, options and who makes the price: market mechanics in ten chapters

What this series is: an explanation, not a measurement. Ten chapters that build on each other, from the origin of futures markets to the question of what option dealers do to the price. All worked examples are computed, not observed in the market. Where our own measurements appear, they are marked and linked. Not a trading recommendation.

Terms such as gamma flip, call wall or liquidity sit on many charts today. They presuppose a chain of mechanisms that is rarely explained in one piece: why futures and options exist at all, who trades them, how a price forms in the order book, why a future follows the index almost exactly, what an option costs and why, and why someone who has sold options then has to trade in the index. This series walks through the chain once, completely, in the order in which one thing builds on the other.

No prior knowledge is needed. Every technical term is explained where it first appears. The mathematics needs no more than basic arithmetic, square roots and the willingness to follow a rearrangement line by line.

The ten chapters

Part I: The market and the future

Why futures and options exist: history, participants and the common thread. From the rice trade in Osaka to the option that expires every day, the six roles in the market and the chain on which all chapters hang.
The market as an auction: order book, market makers and market takers. Derived: the spread between bid and ask that a market maker needs at the very least.
Liquidity: depth, price impact and auctions. How far an order moves the price and when the resting orders disappear.
Futures: what they are, who uses them for what and why their price is tied to the index. Derived: the fair futures price from interest and dividends.

Part II: The option

Options: call, put, payoff, time value and put-call parity. Derived: put-call parity and synthetic positions.
The option price: from a coin toss to the Black-Scholes formula. Derived: the price in the binomial model by replication with the underlying and a loan.
The Greeks: delta, gamma, theta, vega, vanna and charm. One formula and one numerical example each, and the relation between gamma and theta.

Part III: What option dealers do to the price

Hedging in the underlying: long gamma and short gamma. Derived: the result of a hedged book: ½ · gamma · move² minus time decay.
Dealer positioning: open interest, GEX, gamma flip and walls. Derived: GEX per strike and in total, in USD per 1 % move.
What can be measured: the mechanics against our own tests. No derivation, but the comparison with our studies.

Part I explains how prices form and what a future is. Part II explains options up to the point where their price and their sensitivities can be recomputed. Part III shows how this turns into trading in the index and asks what survives a measurement.

How each chapter is built

In one sentence: the core statement up front.
Derivation: every central formula step by step, without jumps.
Worked example: with magnitudes as they occur in the S&P 500, the Nasdaq 100 or the DAX.
Common misconception: a widespread reading that contradicts the mechanics.
What you should understand now: three to five points for self-checking.
Limits: what the model leaves out and what is not shown.

One example runs through all chapters: the S&P 500 at 7,000 points and the E-mini future on it, in which one point is worth 50 USD.

Computed and measured

Understanding a mechanism does not mean making money with it. The chapters describe what market participants have to do and work it through with examples. Whether this shows up in prices in a way that lets a rule survive is a different question. It can only be answered with data.

We have tested many of the widespread claims on these topics. The results are published as separate studies in the research library, each with its data basis, sample and limits. Chapter 10 assigns them to the mechanisms: what is confirmed, what is mechanics only and what failed as a signal.

Notation

$S$ : price of the underlying, that is, of what the future or option is written on. Here mostly the index in points.
$F$ : price of the future.
$K$ : strike price of an option.
$T$ : time to expiry in years.
$\sigma$ : volatility per year, as a decimal (0.16 = 16 %).
$r$ , $q$ : interest rate and dividend yield per year.
$dS$ : a small price change in points.
$\Delta$ , $\Gamma$ , $\Theta$ : delta, gamma and theta of an option (chapter 7).

Amounts are in USD, prices in index points.

📄 The series as one PDF: 69 pages, chapters 1 to 10 with a table of contents and all formulas, tables and figures.

Disclaimer: This series explains market mechanics. It is not investment advice and not a trading recommendation. Trading futures and options involves the risk of loss up to and beyond the capital employed.