I have been studying options for a while and couldn't find any information about this concept, so I'm hoping someone with more hands-on experience can chime in. The setup is a straddle with gamma scalping. Instead of buying options with short expiration date, you buy far away options. I'm thinking 1 to 2 years, but keeping in mind the position will be exit after a few months. The reason is to reduce the negative impact of theta. The problem with this setup is gamma is much lower, so scalping requires larger movements. Since we plan on exiting the position in a few months, it would make sense to consider the delta of near expiry options. By doing so, we'll disconnect position delta with emulated delta. What I mean is our option delta may be +10, but if we consider near expiry options, it may be +20, so we'll have to short 20 stocks instead of 10. The goal is to get more money involved in the scalping process to generate more income. If market crashes or rallies massively, we may end up in a position where our simulated straddle is close to -100 or +100, which means no scalping can take place anymore unless a correction sets the price back to our strike price. In this situation, I'm thinking out straddle would be in profit anyways, so we can exit as normal. It will be less profit, but we paid less time premium so it may cancel out. An extension of this idea for range bound markets would be to simulate a constantly rolled out straddle. For example we want a permanent 60 day straddle. We do a weighted average of the delta of the closest option below 60 days and above 60 days. This would simulate a daily rollout and be useful if we want to keep scalping for more than 3 months without being affected by delta jumps with rolling out the position. The main benefit is we save on roll out costs. In both cases, it requires more upfront money to setup the position. That's money that won't be generating interest or remain usable for other trades, so that's a loss that may or may not be compensated by lower theta decay.
Why don't you try modeling 6 months instead and use the Greeks for those options. You will only make money if during that time period, the SPX is more volatile than the price you paid and VOl does not decrease.
Re: Buy long expiry options, use short expiry delta? How about posting a real example with current quotes? It would be easier to visualize the trade with an example instead of trying to decipher a few paragraphs describing it.
Tibster, the only reason to trade options on the long side is to benefit from *optionality*, when you play with LEAPS, or any long dated options you are basically given that benefit away and exchanged it for pure vega risk (a bad bad trade off if you ask me). When playing long gamma, the best thing to do is to play for short periods of time (very short timeframes) so you can exploit burst of high realized volatility in the underlying (which are usually incorrectly priced in the options), remember that an option dealer is in for the long haul and he has the variance risk premium advantage, so even though there could be a mispricing at a particular day, after many sessions the VRP will show up so he doesn't care about those short moments of high realized vol. However you can just pocket the money and run.
Maverick74, care to elaborate on the disaster potential? Blueplayer, I understand option market makers are like a blackjack dealers. In the long run, they win, but the deck can be in the player's favor at times. I'm also thinking that the greeks are so ingrained in option trading culture that they base their edge off them. Like poker, 15 years ago you could make good money by being tight aggressive since everyone was loose passive, but when everyone shifted to tight aggressive, it no longer worked and you had to be creative to retain an edge. I'll try paper trading it if it still seems interesting, but for now I'm still poking the extremes to see how things behave at the theorical level before doing intensive data mining. The reason why this interests me is because the option market in Canada is pretty bad. Spreads are large so rolling out a position is expensive and LEAPS look like a good alternative if I want near permanent put protection for a buy and hold portfolio with mild scalping from a position that more or less ressemble a straddle payout. Back to straddles, here's an example for SPY that's nearly ATM. That's bid and ask prices as of today. JUN 205 Call : 5.39 - 5.47 / Put : 6.69 - 6.73 SEP 205 Call : 8.11 - 8.22 / Put : 10.20 - 10.35 SEP17 205 Call : 15.07 - 15.38 / Put : 19.48 - 19.71 DEC17 205 Call : 16.36 - 16.75 / Put : 21.30 - 21.65 Let's say the straddle is entered and then closed 4 months later. Using JUN options, max loss is 1220 and locks 1220. Using SEP options and selling 4 months later, max loss is 649 and locks 1857. Using DEC17 options and selling 4 months later, max loss is 385 and locks 3840. As expected, LEAPS lose less value. In theory, if I were to buy DEC17 straddle, then scalp it like JUN straddle and price perfectly retraces, then I only need to scalp 385 to break even. I understand that's the perfect scenario and price will not be there, so let's estimate price movement by looking at various SEP17 strikes. If SPY were to end at 215, then we can estimate 205 options with strike 195. JUN 195 Call : 12.45 - 12.61 / Put : 3.60 - 3.66 SEP17 195 Call : 21.16 - 21.52 / Put : 15.55 - 15.76 DEC17 options lost 169. JUN options would have lost 220 and SEP options 252. If SPY were to end at 225, we can estimate with strike 185. JUN 185 Call : 20.90 - 21.15 / Put : 1.95 - 1.99 SEP17 185 Call : 28.00 - 28.43 / Put : 12.33 - 12.50 DEC17 options made 193. JUN options made 780 and SEP options made 428. As expected, LEAPS make less profit. By throwing scalping into the mix, it makes things harder to estimate. By using the wrong deltas(SEP instead of DEC17), this can leave us in a position where price moves strongly in a direction and we're left with a losing underlying position, but losses are still capped. However, if the market is range bound, then scalping will have higher returns. Since I have little practical experience with options, I can't figure out if I missed anything. It feels to me like it boils down to : Will the market be volatile? If so, will it make a strong move in any direction or will it revert to current prices? Sounds correct?
I hear you Tibster, but believe me, the money in long gamma (long options) is only present at the short term interval trades. Doing long gamma trades that last for months is basically a fool's game. You are giving away all your edge and allowing the variance risk premium to accumulate. I have a simple long gamma optimizer where you can model certain directional scenarios, please play with it and model different trade duration's and let me know what you find: https://gamma-trader.shinyapps.io/demo/
this strategy is overly complicated. On your long option your greatest risk is to vega. On the hedging, You will be overhedging and will be taking all sorts of directional risk. All this might work for you but your real risks are not the risks you want You can't get gamma for free - that is you have to pay for it in the form of theta or vega or both.