This 4-part series covers stocks, options, Greeks and how the SpotGamma methodology uses millions of data points to present actionable options metrics to our subscribers.
SpotGamma.com makes model-driven forecasts based on the open interest in S&P 500 (SPX, SPY) options
Using this data along with some proprietary analytics we produce price and volatility targets which can be used to supplement and trading strategy. There are substantial positions in the options and derivative complex linked to the worlds foremost equity index: the S&P 500 (SPX). The positioning and hedging of these large options positions create movements in the SPX (SPY, E-mini Futures) which we believe can be forecaster.
More importantly our view is that these trading levels are actionable and source of alpha or trading edge.
Below is information and outside documentation supporting the options spot gamma model thesis.
What is Gamma?
Market gamma can be used as a predictive measure of S&P 500 price distribution.
The model is based on the options open interest in the major equity indices. The data is downloaded and calculated each night to produce actionable trading levels.
SpotGamma produces price levels and triggers which can be overlaid on just about any trading strategy:
SPX Gamma Price Distribution
“Total Market Gamma” is often the metric that most people are familiar with. Studies have show that when total gamma is >0 the market tends to have smaller price distribution, with a slightly positive average daily return. When gamma is <0 the price distribution widens out substantially and we estimate a negative average daily return. Said another way things get more volatile when gamma is negative.
This may mean that you select a different trading style depending on the market gamma levels.
We think that markets with high positive gamma tend to be mean reverting with a tight trading range. Negative gamma markets may feature wide price changes with more of a directional basis. Here is an example of what we see as a typical “high gamma” day:
SPX High Gamma Day Mean Reversion
There are several ways to trade these ranges. For instance, if you hold long stock you may want to buy a protective put when the market trades below Volatility Trigger™. You may also want to use the “Call Wall” as a place to sell calls. Or you might find success swing trading between significant levels.
NOTICE: As with any market model, there are no guarantees. This site and its authors offer this information for research purposes only. Major news, events, sudden shifts in sentiment, etc. could suddenly render these market indicators irrelevant. Please mind your risk.
February Stock Market Gamma Chart
Zero Gamma: This is the estimated level at which dealers flip from “long gamma” to “short gamma”. Think of this indicator as the S&P500 level at which volatility shifts from low to high. When the market is above the indicator value traders and investors are more likely to see lower volatility markets due to the options dealers long gamma position . Below the indicator we an anticipate rapid, out-sized moves because dealers are short gamma.
Volatility Trigger™: Based on a proprietary risk model the Volatility Trigger™ is our estimate of the last major level of dealer support or resistance. We generally look for an “air pocket” between this level and the zero gamma level. This differs from the zero gamma level in that below zero gamma, dealers may short (buy) futures as the market declines (rises). The volatility level indicator adjusts daily. Here is an analysis of markets moving through the volatility trigger™.
Call Wall: This indicates a level which could act as a “pin” or “wall” or “floor” for the S&P 500 based on options market maker flows. See the backtest here.
Put Floor: The first put support zone based on our analysis of open interest. Large put positions concentrated at a specific strike could form as “pivots” that hold the market. The theory is that as these large put positions are closed, dealers (who are short these puts, hedged with short futures) back short futures positions, possibly causing the market to head higher.
What is Gamma Flip?
"Gamma Flip” is a term used to mark the stock price at which options dealers are estimated to switch from a positive gamma hedging position to a negative gamma position.
A trader that is net long options has a positive gamma position, and hedges by selling stock as the it goes up, and buying stock as the it goes down. This can have the effect of dampening the underlying stocks movement and creating a low volatility environment.
Conversely, if a trade is net short options then must hedge by selling as the stock goes down, and buying as the stock goes up. This could make the stock more volatile as this trading pressure pushes the stock in its prevailing direction.
Most basic S&P 500 market gamma models assume that options dealers are long calls (positive gamma) and short puts (negative gamma). By estimating the gamma value of these call and puts at different S&P 500 price levels, you may be able to estimate the price at which S&P500 “gamma flips.”
Why Market Gamma Matters
Forget for a second trying to conceptualize what “gamma” means. Ignore all that goes into modeling options across the entirety of the S&P500 index. Because what comes out of all that calculating is one simple number with a large impact: market gamma
Large market gamma is highly correlated to small movement in the S&P 500.
Said another way:
Ever wonder why the market seems stuck in a range for weeks? Or all of a sudden stocks are going crazy?
Market gamma may be your answer.
See the chart below from the Wall Street Journal: as gamma levels increase, one day returns of the S&P500 get smaller.
Gamma versus S&P returns.
Our proprietary option models seek out key support and resistance areas based on large options positions. By understanding when options dealers are estimated to adjust hedging, you may be able to anticipate movement in the underlying stock.
Investment Banks Watch Gamma Levels – Shouldn’t You?
Consider the following recent example of the overnight futures crash following the Iranian bombing. We had noted a key gamma-based level at 3185 and that was exactly where futures bounced.
Futures Bounce Right at Zero Gamma Level
"Dealers being long gamma is like a black hole effect; a negative feedback loop that squishes volatility.”
Global Head of Flow Strategy and Solution, Société Générale
It used to be that you couldn’t get this information unless you were a multi-million dollar fund, or adept at programming and modeling options data.
And that's where SpotGamma comes in.
How does Gamma relate to the S&P 500?
SpotGamma produces daily signals in the S&P 500.
Orange and grey lines provide support and resistance levels. The red line is our volatility trigger. Black is SPX.
All levels are calculated before the trading day and stored with the PREVIOUS night's close. We believe this therefore infers the predictive nature of our data.
SpotGamma Historical Options Gamma Based Levels
In the charts below, notice how large options expiration can mark significant turning points in the market as large options positions roll off and hedges are unwound.