The Data

While this market microstructure should exist in any optionable asset that has market makers
providing the liquidity, we will only explore the SPX. Attempts to reproduce these results on
canadian equities has been mixed.

SqueezeMetrics data goes back to 2004, allowing for a far more insightful picture into the effect
of dealer exposure to the market compared to the 6 months of Spot Gamma data. We may
begin by evaluating the market same-day returns against the market gamma exposure (GEX).

Figure 2: Same-Day market returns vs GEX opening print.

While the returns of the SPX are fairly well distributed two trends are apparent. Volatility, in
terms of absolute movement, is heavily stifled when market gamma reaches positive extremes.
What’s more, is that the largest intraday moves occur when market gamma exposure is
negative.

Negative Gamma Exposure?

When the GEX is measuring positive numbers, it is suggesting that dealers hedge by trading the
underlying, they are taking trades that go AGAINST the movement of the asset. For example, if
the GEX is >4bn then the makers will sell as the asset rises and buy as the asset declines. When
GEX is negative or <0, makers will sell into weakness and buy into strength. This phenomenon
may explain why the largest moves occur when the makers are negatively exposed. Their
trading activity exemplifies the movement already occurring as opposed to counteracting it.

Observant readers will already be foaming at the mouth for an opportunity to trade this
statistical advantage, but we shall continue to explore the data in an attempt to better our
understanding of this signal and produce a trading strategy that may produce excess returns.

The following shows market’s 5-day and 20-day returns against the SqueezeMetrics GEX signal.

Figure 3: 5-Day market returns vs GEX opening print.

Figure 4: 20-Day market returns vs GEX opening print.

For posterity, the same three figures have been produced by the Spot Gamma Machine
Learning model.

Figure 5: Same-Day market returns vs SPOT opening print.

Figure 6: 5-Day market returns vs SPOT opening print.

Figure 7: 20-Day market returns vs SPOT opening print.

A quick review of these plots make the trend abundantly clear. When market makers have
money on the line, they destroy volatility. When market makers want movement, they help
push the index around. In either case, the hedging activities of market dealers clearly impacts
the returns of the market.

Earlier in this report we discussed the possibility that market makers control every print of the
VIX. Before exploring the use of GEX as a trading signal, it felt worthwhile to evaluate the VIX’s
performance alongside the GEX signal. Our assumption is that dealers will tank the VIX index
when they have large amounts of money at risk.
Figure 8: Same-Day VIX returns vs GEX opening print.

Figure 9: 5-Day VIX returns vs GEX opening print.

Figure 10: 20-Day VIX returns vs GEX opening print.

Using the above charts it can be concluded that our GEX model of maker positioning has some
correlation to the VIX index. So now the question must be asked, is this simply a case of the tail
wagging the dog? What if we’ve simply fit the data and the four assumptions are false?
I don’t need to know why, I need to make money.
The Money Maker
Some additional extrapolation from the above figures must be done in order to develop this
signal into a viable trading strategy. Many quantitative investors may seek to optimize against
the data and find the optimal threshold of GEX to fit their desired risk tolerance. I’m quite
happy to draw some lines in the sand and trade around those.

The following data displays the 5-day and 20-day returns for the S&P 500 when market gamma
is above 2bn(Squeeze) and below 0.

Figure 11: 5-day S&P 500 return when market gamma exposure (GEX) is greater than 4bn.
Figure 12: 5-day S&P 500 return when market gamma exposure (GEX) is negative.

Figure 13: 20-day S&P 500 return when market gamma exposure (GEX) is greater than 4bn.