Basic Points

• Market gamma is a metric which gives us a way to model how likely the market is going to stay in a tight trading range.
• The higher market gamma is, the smaller the expected trading range.
• When market gamma is high at a particular price level, then this tends to be a place where price action would slow down or likely reverse.

All Levels: Introduction to Market Gamma

Market gamma can be used as a predictive measure on any security, as well as the price distribution on SPX, which is updated daily in our reports. These models are not perfect since they rely on assumptions, but they are still very strong and help to provide the kind of edge needed for traders to generate positive returns. In Option Volatility & Pricing, Sheldon Natenberg makes it clear why we need models despite their limitations:

A new options trader is like someone entering a dark room for the first time. Without any guidance, he may grope around, hoping that he eventually finds what he is looking for. The trader who is armed with a basic understanding of theoretical pricing models enters the same room with a candle. He can make out the general layout of the room, but the dimness of the candle prevents him from distinguishing every detail. Moreover, some of what he sees may be distorted by the flickering of the candle. In spite of these limitations, a trader is more likely to find what he is looking for with a small candle than with no illumination at all. (2015, p. 56)

But then he closes by saying a model should be good or else it could be like what happens when the candle is dropped, and a financial crisis is started as the room catches on fire! 

Our market gamma model is based on SPX open interest and an industry-standard assumption that market makers are mostly long calls and short puts. The data is downloaded and calculated each night to produce actionable trading levels. 

We also produce price levels and triggers for all major securities, which can be used as strategic guidance on just about any trading strategy. The various price levels can work as floors or ceilings, or pins. For example, with the Volatility Trigger™, if the market moves below (above) this level then realized volatility will likely increase (decrease). 

Intermediate: Strategic Applications

There are several ways to trade ranges between the key levels that we update for you each day. For instance, if you hold long stock then you might want to consider buying a protective put when the market trades below the Volatility Trigger™. 

You might also want to use the Call Wall we provide as a place to write credit call spreads. Or you might find especially strong success swing trading between key levels if they align with large nodes in liquidity or volume. 

To put this into big picture terms, forget for a moment trying to conceptualize what “gamma” means. Ignore all that goes into modeling options across the entirety of the S&P 500 index. Because what comes out of all that calculating is one simple number with a large impact: market gamma. We rank this for you each day on a scale from -4 to +4 in our Gamma Index™. 

In general, large market gamma is highly correlated to small movement in the S&P 500. Said another way, large gamma is usually associated with small price movement, and negative gamma is usually associated with large 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 (July 19, 2019) article on gamma traps. 

As gamma levels increase, one day returns of the S&P 500 get smaller.

<SpotGamma Equity Hub Live Price & SG Levels Chart>

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.

Advanced: Greek Dynamics

Below is a visualization of how gamma (and extrinsic value in general) is sharply concentrated at the money. And so when far away strikes on market maker books approach the money, they face the risk of rapid acceleration in changes of delta in their positions, which create a more urgent need for hedging. 

<SpotGamma SPX Gamma Price Distribution>

“Total Market Gamma” is a metric that many are familiar with. Studies have shown that when total gamma is >0 then the market tends to have a smaller price distribution, with a slightly positive average daily return. 

However, when gamma is <0 then 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 inflection point is what we model on each security to be Zero Gamma. However, the price needs to fall a decent amount below Zero Gamma before negative chain reactions are modeled to ignite, which is where the Volatility Trigger™ comes in. 

This means that you can select a different trading style depending on the market gamma levels, but also make decisions based on the market gamma regime itself with momentum trades having more edge underneath the Volatility Trigger™ . 

Markets with high positive gamma tend to be mean reverting with a smaller trading range, which can give premium-selling strategies an edge so long as the risk is managed well. 

On the other hand, negative gamma markets are prone to 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>

Advanced: Example Use Case

Consider the following example of the overnight futures crash following the Iranian bombing in January 2020. We had noted a key gamma-based level at 3185 and that was exactly where futures bounced.

<Futures Bounce Right at Zero Gamma Level>

Nomura, JP Morgan, Morgan Stanley, and other banks all produce gamma research for their clients.

"Dealers being long gamma is like a black hole effect; a negative feedback loop that squishes volatility.” - Kokou Agbo-Bloua, Global Head of Flow Strategy and Solution, Société Générale 

It used to be that you could not get this information unless you were a multi-million dollar fund, or you had both the time and inclination to do heavy programming to model options data. But with SpotGamma, any trader can have access to data-driven models which capture information across all option chains.