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: October 12, 2021
On October 12, the following metrics for SPX and SPY were shown in the AM Founder’s Note:
- SPX Call Wall: 4500
- SPX Put Wall: 4300
- SPX SpotGamma Imp. 1 Day Move: 2.02% (+- 88.0 pts.)
- SPX SpotGamma Gamma Index: -0.68
- SPY SpotGamma Gamma Index: -0.27
- SPX Gamma Notional: -$463 MM
- SPY Gamma Notional: -$454 MM
The SPX Vanna Model for October 12 showed a significant skew with Delta Notional increasing as SPX drops and decreasing as SPX rises. This indicates market makers would need to sell ES futures to hedge their delta exposure as SPX price moves down and buy ES futures as SPX moves up. The SPX Vanna Model is shown below.
The AM Founder’s Note also pointed out the SPY strikes with high gamma levels at 430 and 440, as shown in SPY Gamma Levels chart below. The note suggested that due to the large negative gamma position, SPX/SPY was not pinning to either strike, but bouncing between the large gamma strikes. This information added to the case for high volatility.
Based on the 2.02% SPX SpotGamma Imp. 1 Day Move, negative SpotGamma Gamma Index for SPX/SPY, negative Gamma Notional for SPX/SPY, the steeply skewed SPX Vanna Model, and the SPY Gamma Levels, I was looking for a high volatility day with a wide trading range. Market makers would likely be trading with the directional movement of the market rather than against it. I expected large moves and planned to look for opportunities to enter in the direction of the movement.
Just after 9:50 AM ET, ES reversed lower. Market maker hedging flow turned bearish, as shown by the HIRO Indicator in the Bookmap chart below. The indicator showed that market makers were selling ES futures to hedge bearish option trades in SPX and SPY as price moved down, confirming the Vanna Model. Based on the metrics noted above, the Vanna Model, and HIRO, I was looking for opportunities to join the move lower. There were several short setups in the morning as ES moved toward 4350 and SPY 434.
The Bookmap chart below shows how the day played out. Although it did not trade in as wide a range as expected, ES was highly volatile during the day, providing multiple opportunities for long and short positions. Price basically followed the market maker hedging flow, as shown by the HIRO Indicator. In the last half hour of the RTH session, ES moved sharply lower and reversed at the Combo L5 level (SPX 4342/ ES 4332), noted as support in the AM Founder’s Note.
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.