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 24, 2021
On November 24, the following metrics for SPX and SPY were shown in the AM Note:
- SPX Call Wall: 4750
- SPX Put Wall: 4400
- SPX SpotGamma Imp. 1 Day Move: 0.62% (+- 29.0 pts.)
- SPX SpotGamma Gamma Index: 0.69
- SPY SpotGamma Gamma Index: 0.05
- SPX Gamma Notional: $278 MM
- SPY Gamma Notional: -$185 MM
- CP Gamma Tilt: 1.16 (Previous Day 1.18)
The SPX Vanna Model for November 24 showed a slight skew with Delta Notional increasing as SPX rises. This indicates market makers would need to sell ES futures to hedge their delta exposure as SPX price moves up toward 4700. The SPX Vanna Model is shown below.
The AM Founder’s Note also pointed out that the largest amount of notional gamma was concentrated at the SPX 4700 strike. With the Volatility Trigger at 4670 and the Absolute Gamma Strike at 4700, the note indicated that market makers would likely have little to hedge in the zone between the two strikes.
Based on the 0.62% SPX SpotGamma Imp. 1 Day Move, positive SpotGamma Gamma Index for SPX, positive Gamma Notional for SPX, and the slightly 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 if SPX moved up toward 4700. 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 after the RTH open, ES moved down below the Volatility Trigger (ES 4666, SPX 4670), noted as support in the AM Founder’s Note, and the SPY 466 Volatility Trigger (ES 4664.75). 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. Based on the rising HIRO Indicator and my expectations for the Volatility Trigger levels to act as support, I was looking for an opportunity to fade this move.
Around 10 am ET, ES began to move higher and then retested the Volatility Trigger levels.
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 Combo L3 level (ES 4680, SPX 4684), and ultimately to the L1 level (ES 4696, SPX 4700). The price action in SPY is shown in the second Bookmap chart below, confirming the reversal at the Volatility Trigger.
The first Bookmap chart above shows how the day played out. For most of the day, ES traded in a range between the Volatility Trigger support level on the downside and the L1 resistance level on the upside. In addition, market makers began to sell ES futures around 1:30 pm ET as SPX approached 4700, confirming the Vanna Model. This is shown by the falling HIRO Indicator in the first chart above as well as the SPY chart. SPX closed at 4701.46, just above the 4700 L1 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.