So, the best candidate is underlying stock which often moves sideways, am I correct ? Also highly volatile (which often comes together). The whole idea is then, to make as many adjustments as possible ?
Its true the best canidates move sideways, but the volatility component of the price of the option will suffer..Gamma scalping to me is somthing that occurs very near expiration as the deltas are moving(gamma) quickly towards 100 or 0. It can be particulary fun to do If you can get your hands on a liquid contract because edges make the difference at expiration.
I don't get it - if you KNEW where the turning points were gonna be, why not just trade the underlying and avoid paying the spread on the option in the first place? The only way this makes sense is if the option was incorrectly priced to beging with, in which case all you would need to do is create a position that was impossible to be worse than at parity at expiration... nitro
All trading assumes that the tradable is "mispriced" -- why would a trader enter a position on a perfectly priced security? With vega trading, the trader believes that they can predict future volatility with more accuracy than the options market has priced into the option. (This gets into the whole battle between traders and believers in the Efficient Market Hypothesis -- the EMHers believe that a single trader cannot outsmart the collective intelligence of the market) The point is that it may be possible to predict future volatility without being able to predict the turning points in the underlying stock -- predicting that the stock will definitely bounce up and down by some amount, without have a clue as to whether the bounce will be up or will be down (or the order of the up or down action). The challenge for the trader is that the value of any single option position is a function of both volatility and price movement. Since the vega trader wants to avoid predicting the direction of price movement, they want to hedge out the impact of delta. In the case of selling vega, the trader is betting that the stock will have much lower future volatility than is expected from the price of the options. This implies that the stock will NOT move much in price and therefore has no profitable stock trades. Selling vega is a way to profit when the majority of the market participants are mistakely overly anxious about the future direction of the market -- its a good play when fears are overblown. Of course, if something happens to justify those fears, then selling vega will lose money. Thank you HTrader for providing a good explanation of delta hedging, including the need to regulate the stock position to compensate for gamma. Have I missed something? Cheers, -Traden4Alpha
Considering HT's example from a different angle, can give some insight into the trade, specifically for the motivation of establishing this type of position and the risks associated with doing so: Assuming I have had enough coffee to properly evaluate his example: purchasing 10 ATM calls and selling 500 shares is the the exact synthetic equivalent of purchasing 5 calls and purchasing 5 puts, i.e. purchasing an ATM straddle. As the market declines, purchasing shares is equivalent to converting the synthetic puts of your straddle to calls, and selling shares is equivalent to selling the calls in your straddle and purchasing more puts. So, if the market declines far enough, you will own all calls, and if market prices increase far enough, you will own all puts. Obviously, establishing the trade is simply purchasing V, and as HT points out, you are hoping for enough volatility to offset the initial premium. An interesting side point: if prices move very steadily far away from the original strike with no gaps and no retracements, the trader would theoretically break even on the initial position and subsequent hedging. The strategy and profit profile is therefore quite different then simply purchasing a straddle: in an up market the hedging is equivalent to selling the calls and replacing them with puts and the trader forgoes what a typical buyer of a straddle would hope for (profit from a sustained move away from the strike) for the profit from backing and filling in a range around the strike price. Interesting stuff. O.
A proper answer to your question would be rather long. At the rate Metoox is going, he could take a couple of years. After driving for 15 hours the last 3 days, I am definitely not up to it. Also, I don't trade Vega off the floor. My experience with trading vega is only as a floor trader. A couple of points. When you "trade vega", it should mean you are focusing on that risk only. Some other posters above have referenced this. If you sell a straddle, volatility could come in yet lose money because the stock rallied. The opposite could happen and did to me once. The stock I was trading was hardly moving, yet, volatility exploded because the world was coming to an end in October 1998. You need to properly hedge your other greeks otherwise vega will become the least of your worries. The easiest was to put on a short vega position is to sell a time spread. Gamma scalp the front month premium and play the vega in the back months. Can't really say I traded this spread effectively. It was part of my downfall. Supposedly, some people do trade this and make money. You would wait until there is a volatility edge between the front month and back. With both options at the same IV, the front month gets hit first. Also avoid selling earnings month vega, these option won't get hit as hard unless IV is abnormally high.