Spot Gamma

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

Market Analysis

The Option Pin / Sticky Strike

Friday (4/3/20) was an interesting day in the S&P500 market due to its rotating action around the 2500 strike. We had several data points that led us to believe that this strike would be key to the action on Friday and wanted to highlight those points. Most of these charts are only available to subscribers but we happened to post this signal out on twitter when the SPX was around 2475:

You can see in the SPX chart below that 2500 was a “sticky strike” and revisited by the market several times.

SPX Options Pin due to large options open interest and options volume.
SPX Options Pin due to large options open interest and options volume.

There are two components we feel contributed to this market action: open interest and volume. As you can see in our gamma chart below, the largest gamma strike was at 2500. This is different from looking at open interest by number of contracts because we weight the open interest with gamma. Open interest may be irrelevant if the strike is way out of the money, so we prefer to look at this gamma weighted open interest metric.

SpotGamma Absolute Options Gamma Chart
SpotGamma Absolute Options Gamma Chart

We think that these high gamma strikes draw hedging activity that influences the market to revolve around that level. This can create something like a “wide range” options pin wherein we tag the level throughout the day as you can see in the SPX price chart at the top of this post.

The second key piece of data is volume. This is both options volume and futures/equity volume. If the volume at the high gamma strike (2500 in this example) is high that can create even more hedging activity tied to that strike. You can see in the chart below that 2500 strike volume was quite high on Thursday, but also Friday as well. We provide charts for subscribers that show the daily change in open interest and volume to help identify these situations.

SPX Put Call Volume for 4/2/20 in the 4/3/20 report
SPX Put Call Volume for 4/2/20 in the 4/3/20 report

The last piece of this setup is to have light futures/equity volume in comparison to options volume. Lower relative volumes in futures mean that the hedging activities of options traders has more impact on the futures market, as options hedging is a higher percentage of equity/futures volume. You can see in the chart below from the CME that futures volume was down compared to previous days.

CME Futures Volume
CME Futures Volume

Note that our discussion here is in regards to SPX index options, we believe options market makers hedge SPX options with ES futures. Therefore those active in SPY or ES futures trading may be able to incorporate this data into their trading.

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Still Question the Impact of Options?

This past March monthly OPEX was one of the largest on record, and featured very large deep in the money put positions. We believed this was a key driver of market volatility in early March, and the change in markets following expiration has been drastic. March OPEX was on 3/20, and it was the following Monday (3/23) that marked the SPX low.

Equally as fascinating was the OPEX in late February (2/21), just prior to the market crash. There were record call positions leading into that expiration, with the market high registering 2/19. Of course the crash began the following Monday after many calls expired.

SPX vs Options Expiration OPEX
SPX vs Options Expiration OPEX

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Zero Gamma = Zero Gravity

We posted a few days ago about the “right” tail risk and the possibility of a market rally. In a note to subscribers we added to this, suggesting the market may be in an airpocket. Specifically: “zero gravity”. Most of you are probably familiar with those flights which take you to the edge of space and allow you to experience zero gravity for a minute or two.

Branson Zero Gravity
Branson Zero Gravity

We think the market may be in this “zero g” now. After a vicious drop we’ve had a strong rally in equities fueled by the rockets of stimulus, fund inflows, short covering and negative gamma. Overall options volume has also been declining and we are past the major stimulus announcements, and “month end” is today which may slow fund inflows.

Gamma levels have come in sharply suggesting options dealers aren’t offering much of a push to markets here (read about negative gamma here).

If you see in the graph of SPY gamma below, we are approaching the zero gamma flip point, but still have several percent to go (Current SPY = ~260).

SPY Gamma Flip Chart
SPY Gamma Flip Chart 3/31/20

The flip point for SPX is even higher, closer to the 3000 point level. As options volumes are low, we are not seeing much appetite for calls which would help to decrease negative gamma. We are also seeing a fairly flat volatility term structure, if volatility would drop it may also help to reduce negative gamma. We obviously want to see positive gamma enter to help decrease volatility and offer some support to the market. The next options expiration with any decent size is 4/17/20, and that may have a decent impact on gamma levels.

SPX Gamma Curve 3/31/20
SPX Gamma Curve 3/31/20

We therefore view this market, at least from an options perspective, as in “zero gravity”. This does not necessarily mean we see a large drawdown or spike higher. It does suggest that more “fundamental” elements of the market may now enter the fray, particularly with earnings season starting.

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Corona Market: Reviewing Right Tail Risk

This is being written just before the 3/26 unemployment data release which is forecasting as much as 2 million unemployment due to the economic shutdown related to Coronavirus. There is also a Stimulus Bill “pending“. While we are all aware of the downside risks here, here is a scenario for a major move to the upside which may occur on any type of positive news. This is not a prediction for higher markets, just a view on upside risk.

As seen in the chart below the market was down almost 35% from peak to trough. We currently have large negative gamma due to the amount of put positions relative to smaller call positions. VIX is still in the 60’s after having peaked above 80. Given some fundamentally positive move markets could make a substantial move higher due to:

  • Long Volatility unwind – many are long vol via SPX puts, VIX or other vol instruments
  • Short Covering – large short interest could be bought back
  • Large Negative Gamma could give fuel to market movement
SPX S&P500 March 2020 Chart
SPX S&P500 March 2020 Chart

Its possible to see a rally up into the 3000 area due to the large call open interest in that area. As you can see in the chart below the most concentrated call interest is at 2900 and higher. In theory this is where positive gamma would kick in and dealers would start to sell into market rallies (and buy dips), helping to reduce volatility.

Call Open Interest March 2020
Call Open Interest March 2020

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The Case for Reduced Price Volatility

Our current view of markets is that we should see reduced price volatility following the large March expiration that took place this past Friday (3/20). One of the features of this expiration was a large number of in the money puts, which possibly created several billion in deltas for options dealers to hedge. As dealers have to hedge these positions they use ES futures, and with active markets they are pushed to pay the spread to ensure filling their order. This may have been a key driver in the massive price volatility we have been seeing in the SPX and VIX.

If you note the chart from JPM below of ES futures liquidity (source) you can see that it is lower than even during the ’08/’09 financial crisis. This indicates that there is now increased slippage to fill an order. For example, if you have to fill 1000 contracts today you may have to pay 5 ticks, whereas in February it would have cost 1 tick.

JPM Estimates ES Futures Liquidity March 2020

However, futures volumes are high (chart below). What this suggests is that while there is little posted liquidity traders are still active and are having to cross the spread to get their orders filled.

Therefore as options dealers were forced to hedge all these large put deltas over the last several weeks, they have had to pay very high spreads to get their orders off. This may in turn have led to very large price distribution, aka volatility as they have to pay prices further and further away from the top of book.

CME ES Futures Volume March 2020
CME ES Futures Volume March 2020

Because these large options positions have expired it may now lead to less dealer hedging and in turn reduce price volatility.

EDIT:

We also came across the following liquidity charts from Heisenberg Report:

SPX ES Liquidity Vanishes
SPX ES Liquidity Vanishes

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