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 Report 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 Example: September 13, 2021
On September 13, the following metrics for SPX and SPY were shown in the AM Report:
- SPX Call Wall: 4500 (down from 4550 on 9/10)
- SPX Put Wall: 4300 (down from 4480 on 9/10
- SPX SpotGamma Imp. 1 Day Move: 1.3% (+- 58.0 pts.)
- SPX SpotGamma Gamma Index: -0.13
- SPY SpotGamma Gamma Index: -0.10
- SPX Gamma Notional: -$235 MM
- SPY Gamma Notional: -$382 MM
The SPX Vanna Model for September 13 showed a downside skew indicating market makers would need to sell ES futures to hedge their delta exposure as price moved down. The SPX Vanna Model for September 13 is shown below.
Based on the 1.3% SPX SpotGamma Imp. 1 Day Move, negative SpotGamma Gamma Index for SPX/SPY, negative Gamma Notional for SPX/SPY, and skewed SPX Vanna Model, 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. Based on the drops in the SPX Call Wall and Put Wall levels, my directional bias was bearish.
Right after the cash open, ES reversed lower just below the Call Wall (SPX 4500 / ES 4480), noted as resistance in the AM report. 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 4450, SPY 445, and the L3 levels below.
The image below shows how the day played out. ES moved lower in the morning, consolidated midday, and then moved lower and reversed at the Combo L3 level (SPX 4448 / EX 4436), noted as support in the AM Report.
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.