Elite Trader

Elite Trader (http://www.elitetrader.com/vb/index.php)
-   Options (http://www.elitetrader.com/vb/forumdisplay.php?f=12)
-   -   Theta scalping? (http://www.elitetrader.com/vb/showthread.php?t=54146)

CalPumper Aug 21st, 2005 10:59 AM

Theta scalping?
 
I stumbled across an idea that strikes me as rather intriguing - selling premium in options (SPY perhaps, many other possibilities), and hedging it with e-mini futures. So one would sell x number of calls in SPY and go long the requisite number of e-mini contracts to get at delta neutrality. Seems like one would effectively be able to collect theta with little risk.

Any thoughts on this as a viable strategy? Thanks again to those who helped me (Maverick, et. al.) in another thread regarding any inherent advantage to buying or selling options - I feel like an idiot in that regard, but better to feel that way than continue down a road paved with false assumptions.

riskarb Aug 21st, 2005 11:16 AM

Re: Theta scalping?
 
Quote:

Quote from CalPumper:

I stumbled across an idea that strikes me as rather intriguing - selling premium in options (SPY perhaps, many other possibilities), and hedging it with e-mini futures. So one would sell x number of calls in SPY and go long the requisite number of e-mini contracts to get at delta neutrality. Seems like one would effectively be able to collect theta with little risk.

Any thoughts on this as a viable strategy? Thanks again to those who helped me (Maverick, et. al.) in another thread regarding any inherent advantage to buying or selling options - I feel like an idiot in that regard, but better to feel that way than continue down a road paved with false assumptions.

It's a delta hedge, but not theta. Gamma risk is the inverse of theta gain. The relationship is nearly linear. It's done every day in every option post/pit extant.

You're replicating a short straddle when trading ATM options -- selling an SPY atm call would require 50 shares of SPY to flatten-delta, and would result in a synthetic straddle. The risk away from the strike[itm or otm] results in trading into the trend; either increasing gamma risk through hedge-reduction[strike-otm] or increasing risk through a larger hedge req[strike-itm, SPY risk].

Reduced; the risk is as you trade further from the strike the risk is magnified as you're matching gamma-position with spot. As you do that, you risk mean-reversion to the strike, which carries the peak of the gamma convexity and risk. In summary, you're gamma-risk increases the further you move away from the strike.

If you trade the spot well you'll do well trading short gamma/vol.

bigarrow Aug 21st, 2005 11:34 AM

Re: Re: Theta scalping?
 
You sound like you really know your stuff. It's all greek to me though.


Quote:

Quote from riskarb:

It's a delta hedge, but not theta. Gamma risk is the inverse of theta gain. The relationship is nearly linear. It's done every day in every option post/pit extant.

You're replicating a short straddle when trading ATM options -- selling an SPY atm call would require 50 shares of SPY to flatten-delta, and would result in a synthetic straddle. The risk away from the strike[itm or otm] results in trading into the trend; either increasing gamma risk through hedge-reduction[strike-otm] or increasing risk through a larger hedge req[strike-itm, SPY risk].

Reduced; the risk is as you trade further from the strike the risk is magnified as you're matching gamma-position with spot. As you do that, you risk mean-reversion to the strike, which carries the peak of the gamma convexity and risk.

If you trade the spot well you'll do well trading short gamma/vol.


riskarb Aug 21st, 2005 11:37 AM

Re: Re: Re: Theta scalping?
 
Quote:

Quote from bigarrow:

You sound like you really know your stuff. It's all greek to me though.
I'm not trying to complicate it, but unless it's dissected it always seems to look like a method to print cash. If the implied distro > the realized spot distro you'll probably earn, but it's no panacea. It's at least as risky as simply selling an ATM straddle. In the majority of scenarios you're probably better-served to sell the atm straddle and buy wings, or offset the straddle.

MajorUrsa Aug 21st, 2005 12:22 PM

Re: Theta scalping?
 
Quote:

Quote from CalPumper:

Thanks again to those who helped me (Maverick, et. al.) in another thread regarding any inherent advantage to buying or selling options - I feel like an idiot in that regard, but better to feel that way than continue down a road paved with false assumptions.
CalPumper,

you're a quick learner and it is always fun to see someone take the hurdles toward understanding options more fully. But I would really recommend you to read a few books on option-strategies, pricing and synthetics. It will take you a month or two to read them and another year to start comprehending, meanwhile losing a little in the markets (paper trading won't do), but believe me, it is the fastest road.

Your next question will be, can you recommend etc. etc..

For basic strategy there are a lot of books, notably McMillan and Fontanills, although both do have disadvantages. For pricing I would recommend Natenberg of course and for synthetics Cottle is best, although you'll need to do a search for the pdf since the book isn't sold.

Anyway, good luck and have fun,

Ursa..

cosine Aug 21st, 2005 01:17 PM

Re: Re: Theta scalping?
 
I find the explaination quite arid too.

The thing, calpump, about what you described is that once delta hedged, an option is still exposed to gamma, which is due to convexity of option in spy's price. As spy moves, you incur losses due to this convexity. There is no free money in finance: as you cash in theta, you lose on gamma, which is the no-arbitrage argument behind black scholes' PDE (see http://en.wikipedia.org/wiki/Black-S...ck-Scholes_PDE). In order to have a perfect hedge, you need to continuously rebalance your delta position. The result is zero expected profit (minus transaction costs, of course).

What riskarb says further (correct me if I'm wrong) is that in the real world, prices may mean-revert. That adds a problem to your strategy. As gamma is higher around the strike, prices mean reverting around the strike will make you incur even larger losses as you rebalance your hedge. Thus the idea that selling an at-the-money straddle might very well end up being more simple and less expensive than a dynamic hedge.


Quote:

Quote from riskarb:

It's a delta hedge, but not theta. Gamma risk is the inverse of theta gain. The relationship is nearly linear. It's done every day in every option post/pit extant.

You're replicating a short straddle when trading ATM options -- selling an SPY atm call would require 50 shares of SPY to flatten-delta, and would result in a synthetic straddle. The risk away from the strike[itm or otm] results in trading into the trend; either increasing gamma risk through hedge-reduction[strike-otm] or increasing risk through a larger hedge req[strike-itm, SPY risk].

Reduced; the risk is as you trade further from the strike the risk is magnified as you're matching gamma-position with spot. As you do that, you risk mean-reversion to the strike, which carries the peak of the gamma convexity and risk. In summary, you're gamma-risk increases the further you move away from the strike.

If you trade the spot well you'll do well trading short gamma/vol.



All times are GMT -4. The time now is 03:33 AM.