The following is a guest post from Doug Pless.
As I have discussed in previous articles, I begin my morning preparation by reading the SpotGamma AM Founder’s Note when I plan to trade futures. For ES futures, I note gamma levels, the SpotGamma Imp. 1 Day Move, the SpotGamma Gamma Index, and Gamma Notional for SPX and SPY.
I also look at the Vanna Model for SPX. This graph shows how market maker delta exposure may shift as price and implied volatility (IV) move up or down. The slope of the lines indicates how aggressively market makers may have to buy or sell ES futures to hedge their delta exposure as price and IV change.
Finally, I watch the HIRO Indicator in the first minutes of trade after the RTH open. The HIRO Indicator shows the market maker hedging impact of options trades. Market maker hedging flow can have a significant impact on order flow in ES and is often a good confirmation of price direction.
Based on this information, I develop a thesis regarding anticipated volatility, trading range, and directional bias for the day. An example of how I used this information to plan and execute a trade in ES futures is shown below.
Trade Analysis: November 11, 2021
On November 11, the following metrics for SPX and SPY were shown in the AM Founder’s Note:
- SPX Call Wall: 4700
- SPX Put Wall: 4000
- SPX SpotGamma Imp. 1 Day Move: 0.72% (+- 34.0 pts.)
- SPX SpotGamma Gamma Index: 1.00
- SPY SpotGamma Gamma Index: 0.00
- SPX Gamma Notional: $350 MM
- SPY Gamma Notional: $37 MM
- CP Gamma Tilt: 1.23 (Previous Day 1.43)
The SPX Vanna Model for November 11 showed a skew with Delta Notional increasing as SPX rises and decreasing as SPX drops. This indicates market makers would need to sell ES futures to hedge their delta exposure as SPX price moves up and buy ES futures as SPX moves down. The SPX Vanna Model is shown below.
Based on the 0.72% SPX SpotGamma Imp. 1 Day Move, positive SpotGamma Gamma Index for SPX, positive Gamma Notional for SPX/SPY, and the skewed SPX Vanna Model, I was looking for a low volatility day with a narrow trading range. Market makers would likely be trading against the directional movement of the market rather than with it. I expected a mean-reverting market and planned to look for reversal setups at key levels.
At the RTH open, ES initially traded higher to the Combo L3 level (ES 4657, SPX 4664), noted as resistance in the AM Founder’s Note. ES then quickly dropped as sellers absorbed buyers, sell stop orders executed, and market maker hedging flow turned bearish, as shown by the HIRO Indicator (green line) in the Bookmap chart below. The indicator showed that market makers were selling ES futures. Based on the reaction at the Combo L3 resistance level, the HIRO Indicator, and the order flow, I was looking for an opportunity to join the move lower.
There were several opportunities to enter short positions as ES pulled back to the SPY 465 level and moved lower. After the pullbacks, ES continued to move down toward the SPY 464 Volatility Trigger (ES 4644.75), just above the L2 level (ES 4643, SPX 4650). The price action in SPY is shown in the second Bookmap chart below, confirming the target at the 464 Volatility Trigger.
The Bookmap chart below shows how the day played out. ES traded in a range between the Combo L3 level above and the SPY Volatility Trigger below for most of the day, providing several opportunities for long and short positions. The highs and lows trended lower for the day, with ES ending the RTH session at the key gamma L2 level (ES 4643, SPX 4650). The trading range was well within the anticipated 0.72% move.
For further definitions and information on the terms used in this article, please see the SpotGamma Support Center for a list of dozens of SpotGamma proprietary terms, as well as context for common market terminology.