The following is a guest post from Doug Pless.
When I plan to trade futures, I begin my morning preparation by reading the SpotGamma AM Founder’s Note. 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 up SPX and SPY in Equity Hub. First, I review the data and note the Hedge Wall and Key Gamma Strike. The Hedge Wall is the strike where the largest change in gamma is detected. The Key Gamma Strike is a strike where volatility may increase or decrease. Both levels can act as pivot or pin areas.
Then I 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: December 29, 2021
On December 29, the following metrics for SPX and SPY were shown in the AM Founder’s Note:
- SPX Call Wall: 4800
- SPY Call Wall: 480
- SPX Put Wall: 4500
- SPY Put Wall: 476
- SPX Volatility Trigger: 4645
- SPX Zero Gamma: 4711
- SPX SpotGamma Imp. 1 Day Move: 0.48% (+- 23.0 pts.)
- SPX SpotGamma Gamma Index: 1.58
- SPY SpotGamma Gamma Index: 0.28
- SPX Gamma Notional: $467 MM
- SPY Gamma Notional: $1175 MM
The SPX Vanna Model for December 29 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 SPX SG Momentum Indicator diagram from Equity Hub for December 29 showed the current price level (PX) below the Hedge Wall and Key Gamma Strike at 4800, noted as resistance. The SPX SG Momentum Indicator model from Equity Hub is shown below.
Based on the 0.48% SPX SpotGamma Imp. 1 Day Move, positive SpotGamma Gamma Index for SPX/SPY, 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 4800 to act as resistance.
After the RTH open, ES moved up and met resistance at the SPX Call Wall (ES 4788, SPX 4800) and SPY 478. Just after 9:40 AM, ES reversed lower as aggressive sellers stepped in and market maker hedging flow shifted from bullish to 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. 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 as ES moved toward targets at 4772 liquidity and the SPY 476 Put Wall. The price action in SPY is shown in the following Bookmap chart below, confirming the reversal at 478 and the target at the 476 Put Wall.
Below, the Bookmap chart shows how the day played out:
- ES traded in a range between the SPX Call Wall (ES 4788, SPX 4800) and SPY 478 resistance levels on the upside and the SPY 476 Put Wall support level on the downside.
- This range was within the SPX SpotGamma Imp. 1 Day Move of 0.48%.
- In the final hour of the session, ES briefly jumped higher above the resistance levels as market makers bought ES futures to hedge their delta exposure, as shown by the HIRO Indicator in the chart.
- SPX closed at 4793.06, just below the 4800 level.
- During the day, there were several reversal setups at key levels, both long and short, as anticipated and planned.
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.