Agreed. In perspective, if you're short gamma, which I presume you frequently are, unlike directional traders which are offered a limited number of tradable 'set ups', there is always theta somewhere to sell.
Funny how you write this... I completely and whole heartedly agree. Short gamma is a dangerous business. When I explain it to people I say the real problem with short gamma is that you have to act first. For example, say I am short a stock and it moves against me 10 points, then I am 10 points in the red. However, with short gamma if the underlying moves 10 points against me I am not 10 points in the red, but potentially 100 points in the red. This is because of the premium factor. Granted you could wait it out, but do you want to take that chance? What are the odds? And if it does not move back, what then? Like you say this is an actuarial business where you need to preserve capital. I do actually roll positions, actually roll them quite a bit. Every month I take about a 25% profit hit since I tend to adjust my positions quite a bit. In a five week cycle I find that I like to adjust them in the first two weeks since then I can still get enough premium. Then for the remainder of the three weeks I play capital control. Rolling positions of increasing risk, I saw it done once, and saw how that person lost 70% of the account. It was quite stunning to watch first hand actually. Hey here is a question for you. You sometimes buy the underlying right? How has that worked out for you. Whenever I run the numbers on it I just can't make it work. Then I talked to a couple of traders and they said it usually only works for those folks (market makers) who have many strikes of the same underlying on various months. Otherwise not much point. Christian
I think the trader needs to be aware of their cost to use the underlying. In my processes, if I'm properly managing risk and making position adjustments to replicate my original play thesis as the market moves around it is normally more wise to use options and either add risk, or move it around. There comes a point however (and this can be determined both mathematically and preferentially) where you may no longer be able to efficiently move delta risk using vehicles which are nearly void of premium. While this will ultimately be determined by the vola of the underlying and its resulting gamma (or visa-versa to be more accurate), I normally begin to incorporate use of the underlying about two weeks from expiration. Consequently, it's also at this point when I begin to pull in my wings and end up with a position which is long unit gamma in the tails. Yes, market makers more fluidly use the underlying, however that's because they have different requirements for their book than you or I do. One of the greatest benefits of retail is that we are not required to take any position we choose against, and so our books may not require us to have that many strikes in play, and we have the freedom to sell premium anywhere we see fit and then take it off at anytime without being forced into or out of a risk position. This does not mean that using the underlying is any different, our tails will just look different. If you are short gamma, use of the underlying should be a net cost in the long run, just the reverse of someone who is gamma scalping and they need their use of the underlying to be a net gainer.
This is true, however in perspective of managing each position, we should not be concerned so much of its p/l - as much as event risk. If you're selling an option you're basically offering yourself up to take a ride on volatility, which is fine if you have this within your expectations set. What a trader should not be willing to ride out is some massive news attack price move in the overnight which blows you to smithereens because you forgot to take off those naked short .15c puts which you 'knew' would expire worthless anyhow. You should always-always-always own some worthless junk in the wings (which the exception of calls if you're on a broad based index or something) so that your net position will eventually go to long gamma/vola if some wing-nut calls in a military-style threat from a ship in NYC harbor, or if trusty old uncle bob on the board of directors decides his teenage daughter is his suitable replacement on the board which he just embezzled non-existant funds from.
I dislike puts on indicies. They are a rough ride... Their risk to reward tend to be quite crappy. Though I tend not to sell puts on individual stocks unless I want to buy them.
For my iron butterflies, I use the ES (s&p 500 emini futures). Of course we want swings, so all short options can be exited with a profit. In the case where there are no swings, then IB's are a challenge--same with IC's. I like to maintain a delta neutral position to start. I like to adjust the delta when it reaches either -50 or +50. In other words, when the positions look like one long ES or one short ES, I like to adjust to keep it closer to zero. I like to use the underlying (ES futures for adjustment). The reason is they cost nothing (extra margin in case where all of my short options on one side are working. The advantage of using the long/short ES is that the upside/downside is unlimited versus another short put or short call whose upside/downside is quite limited (and gets more limited with time). Using as an example the last two cycles: there was no downside movement. (As an aside, the short calls did return to the value at which I shorted them and that was, in hindsight, a good place to exit). Anyway, every time the delta moved over -50, I added an ES. At one point I was able to exit all of the short puts at a place where their value was 80% less than the initial value. I then used long ES to maintain delta neutral. I exited a week ago, when there was very little time value left in the short calls. As you know, once the profitable shorts lose about 80% of their value, they are basically "useless" in keeping up with the short calls. As a result, I had a 4% profit. Now, I am considering making my IB look like a long ES (keeping delta between +50 and +100). The trend is up, and sitting around and "hoping" for a pullback may not be realistic. And if there is one, I will have to act fast to take the profits or break-even from the short calls; the rebounds have been fast. Every strategy needs to be managed. Sharing experiences helps.
Granted. You'll probably have a better chance of hitting a home run with a long gamma single stock play, and I end up trading around a lot of junk in the wings probably more than the ATM but that's just the risk management side of things.