What is Gamma, Market Gamma and/or Total Market Gamma?
Market gamma can be used as a predictive measure of S&P 500 price distribution.
The model is based on the options open interest in the major equity indices. The data is downloaded and calculated each night to produce actionable trading levels.
SpotGamma produces price levels and triggers which can be overlaid on just about any trading strategy:
- S&P500/SPY price levels: These levels can work as floors or ceilings, or pins.
- Volatility Trigger™: If the market moves below (above) this trading level then market volatility could increase (decrease)
SPX Gamma Price Distribution
“Total Market Gamma” is often the metric that most people are familiar with. Studies have show that when total gamma is >0 the market tends to have smaller price distribution, with a slightly positive average daily return. When gamma is <0 the price distribution widens out substantially and we estimate a negative average daily return. Said another way things get more volatile when gamma is negative.
This may mean that you select a different trading style depending on the market gamma levels.
We think that markets with high positive gamma tend to be mean reverting with a tight trading range. Negative gamma markets may feature wide price changes with more of a directional basis. Here is an example of what we see as a typical “high gamma” day:
SPX High Gamma Day Mean Reversion
There are several ways to trade these ranges. For instance, if you hold long stock you may want to buy a protective put when the market trades below Volatility Trigger™. You may also want to use the “Call Wall” as a place to sell calls. Or you might find success swing trading between significant levels.
February Stock Market Gamma Chart
Why does Market Gamma Matter?
Forget for a second trying to conceptualize what “gamma” means. Ignore all that goes into modeling options across the entirety of the S&P500 index. Because what comes out of all that calculating is one simple number with a large impact: market gamma
Large market gamma is highly correlated to small movement in the S&P 500.
Said another way:
- Large gamma equals small price movement.
- Negative gamma indicates big movement.
Ever wonder why the market seems stuck in a range for weeks? Or all of a sudden stocks are going crazy?
Market gamma may be your answer.
See the chart below from the Wall Street Journal: as gamma levels increase, one day returns of the S&P500 get smaller.
Gamma versus S&P returns.
Our proprietary option models seek out key support and resistance areas based on large options positions. By understanding when options dealers are estimated to adjust hedging, you may be able to anticipate movement in the underlying stock.
Investment Banks Watch Gamma Levels – Shouldn’t You?
Consider the following recent example of the overnight futures crash following the Iranian bombing. We had noted a key gamma-based level at 3185 and that was exactly where futures bounced.
"Dealers being long gamma is like a black hole effect; a negative feedback loop that squishes volatility.”
Global Head of Flow Strategy and Solution, Société Générale
It used to be that you couldn’t get this information unless you were a multi-million dollar fund, or adept at programming and modeling options data.
And that's where SpotGamma comes in.