The following is a guest post from Doug Pless.
As I have discussed in previous articles, I begin my morning preparation by reading the 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 Example: October 6, 2021
On October 6, the following metrics for SPX and SPY were shown in the AM Founder’s Note:
- SPX Call Wall: 4500
- SPX Put Wall: 4200
- SPX SpotGamma Imp. 1 Day Move: 1.65% (+- 71.0 pts.)
- SPX SpotGamma Gamma Index: -0.36
- SPY SpotGamma Gamma Index: -0.20
- SPX Gamma Notional: -$600 MM
- SPY Gamma Notional: -$889 MM
The SPX Vanna Model for October 6 showed a significant right side skew indicating market makers would need to sell ES futures to hedge their delta exposure as SPX price moves down and buy ES futures as SPX moves up. The SPX Vanna Model is shown below.
Based on the 1.65% SPX SpotGamma Imp. 1 Day Move, negative SpotGamma Gamma Index for SPX/SPY, large negative Gamma Notional for SPX/SPY, and steeply skewed SPX Vanna Model, I was looking for a high volatility day with a wide trading range.
Market makers would likely be trading with the directional movement of the market rather than against it. I expected more of a trending market and planned to look for opportunities to enter in the direction of the trend.
Right after the cash open, ES reversed lower at the Combo L1 level (SPX 4325 / ES 4315). 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 bullish option trades in SPX/SPY, even as price was moving lower. Based on the Vanna Model and HIRO, I was looking for ES to reverse and move higher.
Around 10:05 AM ET, market maker hedging flow shifted from neutral to bullish as shown in the Bookmap chart below. It looked like ES was ready to reverse and move higher, based on the rising HIRO Indicator. Buy Iceberg orders executed, order flow shifted bullish, and aggressive buyers began to move the price higher. Consequently, there were several opportunities to enter long positions as ES moved higher to the Combo L3 level (SPX 4316 / ES 4306) level and Combo L1 level (SPX 4325 / ES 4315) above.
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.