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 18, 2021
On November 18, the following metrics for SPX and SPY were shown in the AM Founder’s Note:
- SPX Call Wall: 4725
- SPX Put Wall: 4400
- SPX SpotGamma Imp. 1 Day Move: 0.64% (+- 30.0 pts.)
- SPX SpotGamma Gamma Index: 1.79
- SPY SpotGamma Gamma Index: 0.18
- SPX Gamma Notional: $594 MM
- SPY Gamma Notional: $451 MM
- CP Gamma Tilt: 1.39 (Previous Day 1.51)
The SPX Vanna Model for November 18 showed a significant 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.
The AM Founder’s Note also pointed out the prominence of the 4700 strike as shown in SPX Gamma Levels chart below. The note indicated that about 25% was set to expire on the following day. 4700 was expected to act as a target due to the high gamma and interest at that level.
Based on the 0.64% 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. I also expected SPX 4700 to act as a magnet for price.
Just before the RTH open, ES tested the Combo L3 level (ES 4699, SPX 4703), noted as resistance in the AM Founder’s Note, and continued to move lower after the open. At the same time, market maker hedging flow was bullish, as shown by the HIRO Indicator in the Bookmap chart below. The indicator showed that market makers were buying ES futures to hedge their delta exposure as SPX and SPY moved down, confirming the Vanna Model. Based on the high positive gamma, the Vanna Model, and the HIRO Indicator, I was looking for an opportunity to fade this move.
Around 10:20 am ET, ES began to reverse higher after a sell stop run into the SPY 467 Volatility Trigger (ES 4674.75) and the L3 level (ES 4671, SPX 4675), noted as support in the AM Founder’s Note. Market maker hedging flow turned bullish, as shown by the HIRO Indicator in the first Bookmap chart below, and aggressive buyers and buy stop orders continued to move price higher. There were several opportunities to enter long positions as ES continued to move up toward the L2 level (ES 4696, SPX 4700), Combo L3 level (ES 4699, SPX 4703), and ultimately to the primary target at the SPY 470 Key Gamma Strike (ES 4704.75). The price action in SPY is shown in the second Bookmap chart below, confirming the reversal at the Volatility Trigger and the target at the Key Gamma Strike.
The first Bookmap chart above shows how the day played out. ES traded in a range between the L3 level / SPY Volatility Trigger on the downside and the Combo L3 level / SPY Key Gamma Strike on the upside. This range was well within the SPX SpotGamma Imp. 1 Day Move of 0.64%. SPX closed at 4704.54, just above the 4700 L2 level as anticipated.
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.