05.08.22 | Position Trading Using Auction Market Principles and Hedging Flows

The Auction Market Process and Fair Value

Markets are not day-to-day serially correlated.

Value is the key to market understanding.   Time at price, also know as Time Price Opportunities (TPOs) … represent the level at which the market demonstrates the greatest acceptance and thus, represents fairest value.

If you follow changes in value, you can control trading risk.   The position trader seeks to identify market-offered opportunities when price moves well away from value and when breakouts are unlikely to return to the bracket.

Vulnerability

Not to be confused with prediction methods, which focus largely on measures of sentiment, following the auction market process is a determination method.   Sentiment analysis represents an attempt … not to predict … but to identify periods when the price auction is more vulnerable to greater changes … be they reversals or breakouts with continuation.

Following the auction market process relies not upon picking direction … rather, it represents the flexibility to change direction at any point.   A trend reverses when a certain threshold above or below the last key reference level is broken.

Hedging Flows

Gamma exposure (GEX) is a reflection of the delta hedging of options position by dealers.   Gamma is one of the most important flows in equity markets, especially when short gamma exacerbates volatility-of-volatility.   In short, market makers are economically driven to sell equities when they are falling and buy them when they are rising in price.   In a selloff, as dealers become short gamma, their activity hastens the move down and drives up volatility.   When long gamma, market makers buy dips and sell rallies … slowing the auction market process and suppressing volatility.

The Core Strategy:   Follow the Auction and GEX

In the end, it’s quite simple;  buy low, sell high.

The highest probability long is taken when GEX is at a nadir … well below its mean, implied volatility is rolling over, and long-term buyers enter the market at auction bracket lows.

The highest probability short is taken when dealer gamma is dear … having provided liquidity for call overwriting and premium sellers at dips, implied volatility is rising, and long-term sellers sell into efforts to take the auction higher.

Stephen Harlin