Spot Gamma

S&P 500 Stock Market Gamma Trading Levels Based on Options Open Interest

Market Analysis

Feb 12 – Absolute Gamma Bounce

ES Futures moved sharply lower overnight on 2/12-2/13 as fears of the Coronavirus moved higher. This created selling pressure which went unchecked until markets hit the key 3350 level. Its at this level which we measured the highest level of “Absolute Gamma” which the absolute value of call gamma + put gamma. We also calculated that the market was long roughly $1.5 billion in gamma at the 3350 lows – a number which generally supports a “bounce” in markets after a selloff.

2/12/20 - 2/13/20 ES Futures Chart Showing Key Gamma Options Levels
2/12/20 – 2/13/20 ES Futures Chart Showing Key Gamma Options Levels

We think the Absolute Gamma level is notable because it is a level at which many large positions exist, and there should be both large hedging activity and high option volumes tied to that strike. This may cause this level to function as support or resistance as seen in the chart above.

Below is our subscriber chart which outlines stock market gamma exposure and key trading levels. You can see that 3350 was highlighted as a key level heading into the overnight session.

SpotGamma SPX Gamma Options Chart from 2/12/20
SpotGamma SPX Gamma Options Chart from 2/12/20

Yes, Gamma Works Both Ways

There has been quite a rally of of recent lows as the market has been digesting Coronavirus headlines. A bit over one week ago the market was testing the “zero gamma” level – which can present a challenging choice for traders. The chart below shows ES futures with our levels noted from the first week of February – and the subsequent move back to all time highs made yesterday (overnight session).

Low to negative market gamma can fuel volatility: but as we try and emphasize volatility is not directional. Yes, gamma can happen both ways.

February 2020 ES futures chart with gamma levels
February 2020 ES futures chart with gamma levels

Note the chart below which shows Nomuras gamma estimate from early February – and MarketEar’s note regarding “Gamma works both ways.” The idea here is that all of the hedges placed to protect against a Coronavirus impact are unwound – putting pressure on the market to move higher. This is because when long puts are puchased dealers are short those puts – and must hedge shorting futures. When those long puts are closed, dealers have to buy back those short futures.

marketear nomura gamma chart from early february
MarketEar’s posting of Nomuras Gamma Levels from early February

Gamma Model Positioning Adjustments

Following a LinkedIn blog(?) by a Deutsche Bank fellow who took issue with market gamma models, I decided to run a few quick simulations took look at model error. Many gamma models assume all calls are sold to dealers and all puts are bought from dealers. Certainly this cannot be 100% true, but the back data which uses these assumptions is statistically compelling . The blogger does not address any actual data produced via gamma modeling – for instance the chart below showing the 1 day SPX price distribution for positive vs negative gamma. (Note this data comes out pre-open).

price distribution for positive and negative gamma
SPX Gamma Price Distribution 2018-2020

Using the most recent gamma data available (2/7/20) I used excel to visualize how different the gamma distribution may look if we assume that the model is only 50% correct – and the remaining 50% open interest is randomized to be long or short. Just below is our models “normal” chart, with three “random” graphs below that. You can see with those three “random” charts how much the gamma profile can change with a 50% adjustment.

SPX ATM Gamma for Friday 2/8/20 was ~$1.9bn
SPX ATM Gamma for Friday 2/8/20 was ~$1.9bn

I then ran a simulation which stepped through adjusting the models assumption from 50-90%. Running 1,000 trails at 10% intervals from 50% to 90%. 70% for example uses 70% of our base assumptions and 30% randomized. This produced the following total gamma levels:

Rate Adj.Simulation Avg GammaPct of Model
50%             835,000,000,00044%
60%         1,020,000,000,00054%
70%         1,180,000,000,00062%
80%         1,400,000,000,00074%
90%         1,570,000,000,00083%
100%         1,900,000,000,000

As you can see the adjustments to the model assumption can have a fairly substantial impact on overall market gamma rates. Whats very interesting about these adjustments is that data shows (see chart below) when gamma is over ~$1bn its predicted impact effectively “tops out”. In other words a market with ~$1.5bn total gamma is anticipated to perform in the same way as a market with $2.5bn. For markets with >$1bn the model positioning assumptions could therefore be off by a fair amount and still “predict” the same estimated market return.

squeezemerics wsj gamma

“Errors” in positioning assumptions for negative gamma periods would arguably matter less as we look for “high volatility” during negative gamma periods. High volatility does not predict direction, just magnitude of price movement. Therefore changes to underlying positions which in turn effect direction may not violate the models estimate of SPX movement.

A more in depth study of adjustment impacts to the position assumptions is certainly warranted.

Its also important to note that much like most traders and investors market gamma is but one key data points to consider, along with other large options-derived levels.

Somethings Gotta Give – The SPX Box

A quick note, particularly for documentation. Currently (1/31/20) the market awaits a slew of catalysts including: coronavirus updates, Iowa caucuses and the Chinese market reopening. For the last few days we’ve been contained in this fairly volatile range between ~3300 (our high gamma strike) and ~3240 (zero gamma). Above we can bask in the comfort of high gamma, below may set the gamma trap.

ES futures SPX stock market range chart with gamma levels
ES futures SPX stock market range chart with gamma levels

ZH released the latest Nomura gamma charts, showing the calculate zero gamma at ~3255 meaning we are currently in negative gamma territory (SPX=3240). Our model shows 3234, as seen below.

nomura spx gamma chart 1/31/2020
Nomura gamma chart 1/31/20

Here is our gamma chart for JUST the SPX. Nomura combines SPY/SPX.

SpotGamma Gamma Chart 1/31/2020
SpotGamma Gamma Chart 1/31/2020

Currently its clear that the zero gamma level is playing into things. Note the ES futures chart with an inset of key levels from our 8AM report.

ES Futures versus the SpotGamma key gamma levels
ES Futures versus the SpotGamma key gamma levels

Closing Update: Large move lower after breaking zero gamma, kick-saved into the close.

ES futures closing update under zero gamma 1/31/20
ES futures closing update under zero gamma 1/31/20

Virus Outbreak – Week in Review

Ahead of important AAPL (Apple) earnings and the FOMC we wanted to review the market over the past week. We have spent a lot of time drawing an analogy between todays market and that of January ’18 (see here). Interestingly the Jan ’18 market topped the same day as the current market. Currently gamma is low, which frees the market up for a larger move. This may well be catalyzed by AAPL earnings and FOMC. AAPL earnings may be of particular note because of their exposure to China and the possible supply chain disruptions due to Coronavirus.

ES futures (SPX) Weekly chart for January 2020
ES futures (SPX) Weekly chart for January 2020