The following is a guest post from Doug Pless.
As I have discussed in previous articles, I begin my morning preparation by gathering information to help develop a thesis for the day when I trade futures. My thesis includes the following items:
- Directional bias
- Anticipated volatility
- Trading range for the day
My primary sources of information for ES futures are the SpotGamma AM Report and the SPX Vanna Model. From the AM Report, I note gamma levels, the SpotGamma Imp. 1 Day Move, the SpotGamma Gamma Index, and Gamma Notional for SPX and SPY.
The Vanna Model for SPX 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.
An example of how I used this information to develop a thesis for the day, confirm my thesis, and plan and execute a trade is shown below.
Trade Example: August 31, 2021
On August 31, the following metrics for SPX and SPY were shown in the AM Report:
- SPX SpotGamma Imp. 1 Day Move: 0.66% (+- 30.0 pts.)
- SPX SpotGamma Gamma Index: 1.94
- SPY SpotGamma Gamma Index: 0.29
- SPX Gamma Notional: $891 MM
- SPY Gamma Notional: $1362 MM
The SPX Vanna Model for August 31 showed a significant upside skew indicating market makers would likely need to sell ES futures to hedge their delta exposure as price moved up toward 4550. They would probably need to buy futures as price moved down. The SPX Vanna Model for August 31 is shown below:
Based on the large SpotGamma Gamma Index, large positive Gamma Notional for SPX and SPY, and skewed Vanna Model for SPX, I was looking for a lower volatility day with a narrow trading range. Market makers would likely be trading against the directional movement of the market rather than with it.
Immediately after the cash open, market maker hedging flow turned bullish even as price was moving down, as shown by the HIRO Indicator in the Bookmap chart below. The indicator showed that market makers were buying futures to hedge bullish option trades. HIRO confirmed the Vanna Model indicating that market makers were buying ES futures as price moved down. After a sell stop run into 4513.50 (SPY 451), order flow and hedging again shifted bullish and aggressive buyers moved price higher. There were several opportunities to enter long positions as price moved up to the Combo L1 level and beyond.
In this trade example, I anticipated lower volatility and a narrow trading range. I also thought market makers would likely be trading against the directional movement of the market rather than with it. Watching the market maker hedging flow as shown by the HIRO Indicator in the first 15 – 30 minutes of trade helped to confirm my thesis. Based on the Vanna Model and HIRO, I was looking to fade the initial move down and waited for price to reverse and move in sync with the hedging flow and order flow before looking for bullish trades.
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.
SpotGamma Products Used: