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 5, 2021
On November 5, the following metrics for SPX and SPY were shown in the AM Report:
- SPX Call Wall: 4700
- SPX Put Wall: 4000
- SPX SpotGamma Imp. 1 Day Move: 0.66% (+- 31.0 pts.)
- SPX SpotGamma Gamma Index: 1.79
- SPY SpotGamma Gamma Index: 0.10
- SPX Gamma Notional: $728 MM
- SPY Gamma Notional: $1030 MM
- CP Gamma Tilt: 1.56 (Previous Day 1.71)
The SPX Vanna Model for November 5 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 17k calls were added at that level the prior day. 4700 was expected to act as a target due to the high gamma and interest at that level.
Based on the 0.66% 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 the Combo L4 level (ES 4712, SPX 4719) 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. Based on the high positive gamma, the Vanna Model, and the HIRO Indicator, I was looking for an opportunity to fade this move.
Just after 10 AM ET, ES reversed lower as sellers absorbed buyers, sell Iceberg orders executed, and market makers continued to sell. There were several opportunities to enter short positions as ES continued to move down toward the Call Wall (ES 4693, SPX 4700), Combo L1 level (ES 4684, SPX 4691), and ultimately to the primary target at the SPY 467 Volatility Trigger (ES 4674.75). The price action in SPY is shown in the second Bookmap chart below, confirming the target at the Volatility Trigger.
The Bookmap chart below shows how the day played out. ES traded in a range between the Combo L4 level and the SPY Volatility Trigger. After reversing sharply at the Volatility Trigger around 1:30 pm ET, ES traded in a narrow range between the Combo L1 level and the Call Wall for the rest of the session. SPX closed at 4697.53, just below the 4700 Call Wall 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.