charm exposure

Now that vanna exposure is accounted for, the good news is that we can finally take it easy. The analogy between IV and time until expiration is quite strict, meaning that we can understand charm exposure by means of some substitutions and convention changes. Charm is sometimes called delta decay, because it describes how delta changes as expiry approaches (in units of deltas per year). As you may recall, this is the opposite of vanna, which describes changes in delta as volatility rises. We can perform the same thought experiment as above to gain an intuitive sense for charm:

While the delta of ITM options increases in absolute value as time runs out, the delta of OTM options decreases in absolute value (they expire worthless).

So what about charm exposure? For each strike, 100 × charm × OI tells us how many shares we would need to hedge the delta decay of those contracts for an entire year. In order to get a more intuitive result, we divide by 365 days × 24 hours to get the shares needed per hour. Finally, we multiply by spot price to get the capital required for this hedge. Thus, our charm exposure charts approximate the capital required to hedge current inventory per hour, assuming all other variables are held constant. Once again, short options are netted out against long options for cleaner visualization.

Unlike vanna exposure, charm can be aggregated. We can directly compare the impact of 0DTE with 1DTE, and so on, as all are in units of dollars per hour.