Anyone use these techniques in some form? I wanted to start a discussion, for I am considering doing reverse gamma scalping using short straddles (futures options on the S&P emini's). I plan to add ES hedges when the portfolio's delta becomes -50 or +50. I am not seeing the problems with this technique. Certainly, it appears that one's losses are greatly reduced. There seems to be enough premium taken in to combat reversals and extended moves in one directions. Any comments appreciated from those that have used this technique.
Testing something similar to it right now, IMO better to own wings to hedge downside (short stradd + otm put) and concentrate more on hedging upside risk. Just my take, based on flash crash, dubai world, moves which you have to be a lot quicker to hedge on the downside. Dubai world was 2am on the day before Thanksgiving IIRC, ES dropped 20+ pts before rebounding, who the f is going to be up awake to hedge that? Unless your hedging is automated. Upside hedging, though probably more frequent, is easier to manage, again imo.
Really? Not seeing the problems? Try testing in market conditions other than present conditions. Let's see, randomly picking a year, how about 2008. Also, reverse gamma scalp hedging or hedging any short premium with the UL is always a tough trade - risk mitigation is difficult when you're fighting on two sides. Personally, I wouldn't try this in size. I'll gamma scalp in size. Generally, you have to - for any decent profit.
JW, recently there was a thread where the OP complained that so many replies are,"you shouldn't do that." You don't have to agree with anyone telling you not to try something. There are many different trading styles and sometimes posters get that mixed up with what is feasible and what isn't. However, what you are proposing is very difficult. It may be feasible short term, but I doubt that it would work out well long term. It may be profitable more months than not, but the potential for heavy losses is always there.
How do you know that you're selling your straddles for the right price? In other words, how do you know this strategy actually makes money? Do you have a way of forecasting volatility?
Tho I'm not familair with your underlyings nor have I reverse gamma scalped, I imagine that apart from UL movement risk that Donnap mentioned, it's not much different than GS-ing against long options - you have to get the IV right as well as the adjustment frequency and AFAIK both hit or miss. A lot of it depends on whether the UL cooperates with your guesses IOW, if you long GS at +/- 50 delta and it's a multiple +/- 25 delta day, you miss out on a lot of trading opportunites and multiple small profits. OTOH, if you GS at 25 and the UL trends to 50, you've reduced your day's profit as the added UL scalp becomes a drag.
I mean, this pretty much says it all. Your expected profits will be a function of realized volatility versus the implied volatility that you sold. If you're able to predict that with any sort of accuracy, I'd suggest you just sell VIX futures.
Appreciate the comments. I like the suggestion of using an iron butterfly in place of the short straddle. I checked, and the margin requirements really drop for the IB. I also looked at adjustments at the absolute value of delta at 25 vs 50. I prefer to use the underlying ES futures (delta of 50) to adjust rather than using an ATM option (delta of 25). Using the ES futures has no effect on the gamma, vega, and theta of the IB--which is ideal. So, I like adjusting when the absolute value of delta is 50. I worked through some scenarios using an IB and reverse gamma scalping. Obviously, the fewer adjustments needed, the higher the profit (the theory of mean reversion lives). I have even noted that a profit can be had even if the underlying surpasses the wings. The market does trade in a range often, albeit a wide range these days. By RGS (reverse gamma scalping), the loss as the underlying approaches the wings, is very much smaller than the short straddle. Obviously, as volatility decreases--that's plus for the IB. The bottom line, it always seems , is that gamma, theta and vega affect delta.
its a good strategy, and you are on the track, keep your size manageable and you will make money. overleverage is the killer, if you keep your size moderate you will do great in the long run if you know how to adjust your positions.
My suggestion about 25 vs 50 was in response to your first post that indicated that you would adjust when the portfolio's net delta becomes -50 or +50. I was not implying that you should use 25 or 50 delta options to make your adjustment. Fewer adustments does not necessarily mean greater profit. If the UL is ping ponging back and forth all day causing your net delta to swing back and forth from -35 to +35, an adjustment level of 50 means you do nothing. If 25, you may get numerous scalps. And if you trade at delta 50 but it doesn't reverse, then the net outcome for the day will be inferior. And to repeat the disclaimer, my comments are from long GS-ing experience and I have no idea if they pertain to your adventure