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 22, 2021
On October 22, the following metrics for SPX and SPY were shown in the AM Founder’s Note:
- SPX Call Wall: 4550 (previous day 4500)
- SPX Put Wall: 4300
- SPX SpotGamma Imp. 1 Day Move: 0.53% (+- 24.0 pts.)
- SPX SpotGamma Gamma Index: 2.24
- SPY SpotGamma Gamma Index: -0.02
- SPX Gamma Notional: $588 MM
- SPY Gamma Notional: $859 MM
The SPX Vanna Model for October 22 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.
Based on the 0.53% 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.
ES initially traded higher to 4550 after the RTH open. At the same time, market maker hedging flow was bearish, as shown by the HIRO Indicator in the Bookmap chart below. The indicator showed that market makers were selling ES futures to hedge their delta exposure as SPX and SPY moved up, confirming the Vanna Model. Right after 11 AM ET, traders reacted to a news event, sending ES sharply lower to the L2 level (ES 4518 / SPX 4525). This level was noted as support in the AM Founder’s Note. Based on the high positive gamma, other metrics noted above, and the Vanna Model, I was looking for an opportunity to fade this move.
The down move ended with a stop run into the L2 level and SPY 451, as shown in the Bookmap chart below. In line with the high positive gamma and expectations for the day, ES stopped at this level and began to reverse higher. Buy Iceberg orders executed, market maker hedging flow and order flow turned bullish, and aggressive buyers began to move price higher. There were several opportunities to enter long positions as ES made its way back to the Call Wall and SPY 454 above. The day generally played out as expected, even with a large news event. ES traded in a range between the Call Wall and L2 level, providing several opportunities for long and short positions.
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.