If you go short Gamma, then your goal is to earn the time consumption. Delta hedging helps you to protect the position from being damaged by underlying movement, there are no news about it: if you short Gamma and IV drops towards expiration, your Delta hedging will make money (I'm not considering bid-ask spread and transaction fees). Now consider a long Gamma position, like a simple long straddle: if the underlying moves far away from the strike(s), you start earning. Here is the so called 'let Gamma run' technique, which is nothing more complex than to not cover the Delta. Here is my question: if you correctly predicted the IV movement, what is better? I mean: let the IV starts rising after you opened that long straddle. In your opinion is it better to cover the Delta with the usual frequency or to let the Gamma works? In the first scenario (Delta hedging), you will probably benefit of a P&L which rises but with no slope; in the second scenario (Gamma run) there's nothing to say: your position will behave like a long/short on the underlying if the underlying continues its trend. Obviously some of you will probably tell me that they will let the Gamma work until some threshold, then cover the Delta... but my question is about extreme examples. What do you think?
If you don't have any edge, gamma scalping is not going to do anything for you. So the decision to let your deltas run or hedge them is a moot point.
Thank you for the answer, Maverick74. Suppose you have a positive edge because you are in the following situation: - long Gamma; - you correctly predicted an increasing in historical volatility (i.e. underlying movement); - you correctly predicted an increasing in implied volatility. What would you do in such a situation?
Then sell it! Seriously, don't scalp it. If you either get a sharp move in the underlying you are much better off taking your profits then scalping the gamma and watching your profit turn into a loss. And vice versa if you buy cheap implied vol and it spikes just sell it, don't hold it watching the vol come back down. And by edge, I mean you have some quantitative process that allows you to price an option better then 95% of the market. Because if you can't do that, you are going to find it difficult to make money. You will always cut your winners short and hold on to your losers too long. You need a solid edge and you need to trade a lot to realize that edge.
Ok, understood. If the position is in profit, you suggest to close it with gain. Now, if we introduce the bid-ask spread and transaction fees, it's possible that the underlying moves, our position gets better but we do not cross the break even point, yet. As in this situation you can't close the position because of the loss, you have to choose between waiting for an additional movement and covering the Delta. What would you do?
If you are losing money then your position is not getting better, it's getting worse. LOL. I think you are better off trading the underlying 9 times out of 10. There are 50 different ways you can lose money trying to manage the options position, only one way to lose money trading the underlying. Keep it simple stupid as the saying goes.
Probably I didn't properly explain the situation I mean: when you open every position you're always in loss because of the bid-ask spread, right? Now let the underlying moves and suppose you are in a long straddle: you see your P&L getting better but that movement would not be strong enough to overcome the loss caused by the bid-ask spread. In that situation I could be uncertain about what to do with Delta and Gamma. Did you understand what I mean? (excuse my poor English).
The bid-offer spread is negligible. And the spread is irrelevant to when you hedge. If the spread was .05 or 1.00, why would that matter when you hedge. You have to hedge when you have to hedge. Honestly man, I'm trying to offer you some help here. If you trade on the floor and you can earn the spread, then scalping makes sense. Otherwise you better be damn good at pricing options.
Ok, I thank you for the answer and I think that I understood your point of view. Nevertheless, it does not seem to me that the bid-ask spread is negligible. If I open a position hitting the market maker's quotes, I usually see large losses from the beginning because of the bid-ask spread. Then in need to perform well just to reset the bid-ask spread in the first time, and only in the second time I can choose between closing the position in gain, letting Gamma run or hedging the Delta is the best move Thank you for the help!
Are you entering highly liquid options? Spread should be fairly neglible in most cases-- if they're not you should consider filtering down to underlying with $.05-$.10 option spreads. What triggers are you using to enter a long straddle... a tight consolidation pattern or wedge? Hopefully not where support or resistance is...