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: February 7, 2022
On February 7, the following metrics for SPX and SPY were shown in the AM Founder’s Note:
- SPX Call Wall: 4700
- SPY Call Wall: 460
- SPX Put Wall: 4300
- SPY Put Wall: 440
- SPX Key Gamma Strike: 4500
- SPY Key Gamma Strike: 450
- SPX Volatility Trigger: 4520
- SPX Zero Gamma: 4554
- SPX SpotGamma Imp. 1 Day Move: 1.31% (+- 59.0 pts.)
- SPX SpotGamma Gamma Index: -0.57
- SPY SpotGamma Gamma Index: -0.22
- SPX Gamma Notional: -$413 MM
- SPY Gamma Notional: -$897 MM
The SPX Vanna Model for February 7 showed a significant skew with Delta Notional increasing as SPX falls and decreasing as SPX rises. This indicates 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.
The SPX SG Momentum Indicator diagram from Equity Hub for February 7 showed the current price level (PX) near the Hedge Wall and Key Gamma Strike at 4500, noted as support. The bright red color indicates robust options activity and that puts are driving the price action. The SPX SG Momentum Indicator model from Equity Hub is shown below.
Based on the 1.31% SPX SpotGamma Imp. 1 Day Move, negative SpotGamma Gamma Index for SPX/SPY, negative Gamma Notional for SPX/SPY, and the 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 large moves and planned to look for opportunities to enter in the direction of the movement.
After the RTH open, ES traded in a range between the Combo L4 level (ES 4490, SPX 4498) and the Volatility Trigger (ES 4512, SPX 4520), noted as resistance in the AM Founder’s Note. At the same time, market maker hedging flow was bearish, as shown by the downward-sloping HIRO Indicator (green line in the sub-chart) in the Bookmap chart below.
The indicator showed that market makers were selling ES futures to hedge bearish option trades in SPX/SPY. Around 10:20 am ET, a large negative delta options trade(s) executed as shown in the second Bookmap chart below. This indicated market makers would need to sell more ES futures.
Based on HIRO and the expectation for the Volatility Trigger to act as resistance, I was looking for a reversal at that level and opportunities to join the move lower.
There were several short setups as ES moved toward targets at the L3 level (ES 4492, SPX 4500), Combo L4 level (ES 4490, SPX 4498), and 4480 liquidity below.
The first Bookmap chart above shows how the day played out. ES traded in a range between the SPX Volatility Trigger (ES 4512, SPX 4520) resistance level on the upside and SPY 446 (ES 4465) on the downside. In the final hour of the session, ES retested the Volatility Trigger and then moved sharply lower as market makers sold ES futures to hedge their delta exposure into the close, as shown by the HIRO Indicator in the chart.
ES moved up and down in a 50-point range for the day, providing several good opportunities to enter long and short positions in the direction of the trend during the day.
Finally, market makers were indeed trading in the direction of price movement (buying strength and selling weakness) as anticipated. This is shown in the SPY HIRO chart shown below that was posted in the PM Founder’s Note.
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.