I wonder if any of the guys here is used to this strategy. I am very impressed by how it works (noob I am) and thinking if in an overstreched mkt (technical view) like the current level of spx, a straddle gamma scalped everyday until some (hypothetical) breakout can be daily profitable play. For example an ATM straddle on the spy, gamma hedged to BE to compensate for the theta bill and then scalp for a profit new deltas while waiting for a substantial move to break either leg . Seems cool but not sure If I really do understand this thing?
A couple of problems in practice. You can (and will) miss your scalp entries. You're to be long at 1832.50 ES and it trades down to 33.50 and rallies 6 in your face. Exceeding realized vol (RV > IV) assumes it's frictionless. A lot of ppl will enter too early or miss the hedge entirely. Second, you're not going home flat, so the position is never outright long the combo. Say you're long 5 ES straddles and long 1 fut against. Spot drops 30. Straddle is 120 short and futures are 100 long. You're long gamma (short speed), so that number will increase (combo delta), but obv not as though you're outright long the combo.
"Gamma scalping" is just a fancy way to say deltahedging. When you deltahedge, the majority of risk goes to volatility. The strategy you propose is very well studied in the literature, and overall the returns on blindly shorting vol is a tad bit better than long equity, but that's it. BTW I have tried before to subjectively "gamma scalp" whenever I feel like there's a breakout etc. and it's just pointless. You will miss entries as drownpruf said, and just mess up. Better to scalp at some fixed delta figure tolerance IMO, and then you're essentially just short/long vol.
if you are thinking that it will head down why not scalp a backspread instead? I never had much luck scalping indices, although I always heard a good rule of thumb is to scalp your position when your delta equals your gamma.
Many thanks to you guys. As we say no free lunch in these things. At least it allows to understand a bit more how it really works. Edit: BTW I am really impressed by how well you know the subject. I think that i'll have to brush my maths up on these differential and stochastic stuff . Thanks again.
Here is an old post where I showed my clumsy method of scalping a long straddle in QQQ: http://www.elitetrader.com/vb/showthread.php?t=15395&page=2 Never got anywhere with it. I found plenty of easier ways to make a buck.
Market makers are major players in the gamma-scalping arena. As they take the other side of public trades, they hedge the deltas and subsequently scalp gamma of long option positions. In a way, the gamma scalping of market makers links together implied and historical volatility. For example, if the stock isn't moving enough (i.e., historical volatility is too low) for market makers to cover theta, they lower their markets (i.e., they lower implied volatility). However, a typical retail trader will rarely gamma scalp. The decision as to how much a trader will allow a delta to build or accumulate before hedging is a personal risk preference, but one typically driven by technical expectations and / or more theoretical considerations such as keeping oneâs daily theta or time decay risk to an acceptable level. --------------------------------- <a href="http://www.optionstack.com/"> Options Backtesting Service </a>
A burning question with Gamma Scalping always seems to be "When do I hedge". Am I crazy or isn't Gamma Scalping simply the buying & selling of an underlying and basically dollar-cost averaging your way to small profits over time? All Greeks aside, shouldn't the criteria for when to hedge simply be determined by whether or not the Sale (or Purchase) of the stock at it's current price is helping or hurting your cost average?
The way I see it, there are many different opinions on delta hedging. After a lot of reading, live market implementation, and hundreds of mistakes, I've learned just how much of an art form this style of trading really is. The topic evokes a ton of questions which seem to have different answers depending on what type of market participant you are and what your goals/risk management needs are. To the original poster who started this topic, yes you are right that if you long an ATM straddle, delta hedging is a means to pay your theta rent over the life of the option. In fact, the concept of delta hedging is one of the pillars of option pricing. The basic Black-Scholes pricing model is based on a no-arbitrage argument: Namely that the payoff of a vanilla European option can be replicated by holding and dynamically rebalancing a portfolio of the underlying instrument and risk-free bonds/cash. Since the prices of the underlying and risk-free rate are readily available, and we know that dynamic replication will yield the terminal payoff of the option in question (hence the two must be equal under threat of arbitrage), the option price must be equal to the set-up cost of this "self-financing" hedging portfolio. This is what Black-Scholes does. In actuality, Black-Scholes takes your inputs for underlying price, volatility, risk-free rate, expiry, and strike and calculates the total cost of a hedging portfolio, not an option. You just assume the two are equal. The point is that is all basic theory. Among other things, Black-Scholes assumes frictionless markets, continuous hedging, constant (or time-dependent) volatility, etc. In practice, we all know that these assumptions are clearly violated or impossible to implement. The important point to remember is that Black-Scholes has proven itself to be remarkably robust even when traders hedge discretely and even use the wrong volatility input. Perhaps the best way I can think about delta neutral trading is this: If I believe vol over the next 2 weeks will be 15% and I can buy options trading at 10%, my expected profit is 5 vegas as calculated via Black-Scholes. And that's assuming I am right about vol. Of course I don't know, and I'm hedging discretely in a non-Black Scholes world. So while Black-Scholes may be right ON AVERAGE, my P&L is going to have variance. It is my goal as a trader to develop strategies in which I can place as many bets as I can with a positive expected value and do my best to control variance. If I hedge the fat tails and size my bets appropriately, I should be able to invoke the Central Limit Theorem over time and realize a positive drift rate for my portfolio. In conclusion, yes delta hedging is useful, and not just for long straddles. But only if you have some type of thesis as to why vol is cheap/rich. If it is truly cheap, the summation of your delta hedging cashflow will exceed the premium paid for the option and you will realize a profit. If the option is a fairly valued, its a scratch. If the option is rich, your delta hedging will be insufficient and you will take a loss. But there are other important questions, such as what volatility do you hedge at? Implied vol? Actual vol? Something different? Each one will give you a different delta and therefore a different risk-profile to the hedging strategy. There's a ton to learn on this topic. It's my preferred way of trading, but it has taken me years to begin even feeling out a strategy that I'm comfortable with and believe I can be successful with. Always happy to discuss and hear what others have to say on this stuff.