Long Gamma/Vega Neutral

Discussion in 'Options' started by CPTrader, Nov 29, 2008.

  1. What's the best position/spread to achieve positive gamma but with vega neutrality. In essence, one expects the market to make a good size move but fears that the move may not be accompanied by an increase in volatility, thus making the long straddle/long strangle an unacceptable option since the long straddle/long strangle is along gamma and long vega.

    So a position is needed that will benefit from market movement via positive gamma, but is neutral to implied volatility via vega neutrality.

    What spread will achieve this?

    Thank you.
  2. Near-term, ATM straddle/strangle. If you anticipate a big move, the high gamma of the near-term will off-set much, or all, of the vega risk. If these options move deep ITM, per your expectation, the vega effect becomes minimal.

  3. Thanks, are you sure the vega risk is minimal? What happens when implied vol is sufficiently high, say after a recent market fall....then the market subsequently rallied sharply while vols get crushed. In such a scenario you can be right about significant movement but lose money due to vega risk with declining implied vols.

    I am not sure with a near term ATM straddle you achieve the desired vega neutrality.
  4. dmo


    Buy front month options and sell back month options at a ratio that makes you vega neutral. You will end up long more front month options than you are short back month options, and on top of that, each front month option will have more gammas than each back month option (assuming your front and back month options are approximately equidistant from the money). So you will end up vega neutral and long gammas. Of course, you will have some spread risk.

    If the front month volatility is extremely pumped up, you could buy back-month options and sell further-back-month options, which would probably decrease your spread risk, depending on the "tilt" (the month-to-month implied volatility curve).
  5. Thanks just to be clear because people use front/month differently; when you say front month you mean the longer dated option and when you say you back month you mean the shorter dated options. so in Nov 2008, you would mean Buy Jan Options/Sell Dec Options. Correct?
  6. Hi CPTrader

    What DMO suggests is the way to go. Its a good idea to have some software displaying your greeks and exposures too so that you are ontop of your positions and can make decisive trade decisions if your forecast event occurs.

    In current High Implied Volatility environment what DMO suggest should work if your view materialises. If it doesn't you stand to run a bit of a daily theta Bill.
    If your view is that the market will bounce up and down for the near term then be prepared to delta neutralise at the end of each day (maybe even intra-day if markets are very crazy)with futures or Cash trades locking in profits that hopefully more than offset your daily theta bill.

    It all boils down to having a management tools be it off-the-shelf or just self made spreadsheet model.

    ANother strategy although a Diagonal Option strategy (all option trades of the same expiry) is to buy say 10 out the money puts and 7 Out-the money calls. Then sell say 10 ATM options. Adjust the OTM strikes to make the position vega and delta neutral.
    Now if the market goes up, you will get swung long delta and long vega. If the market goes down you will get swung long vega and short delta, If Implied Volatility jumps you will get swung long vega, and if implied volatilty drops, you will get swung short vega. Again, very important to have a management tool to help you with your trading decision
  7. Front month is the closer expiry and back month, is further out.
  8. dmo


    No, just the opposite. The front month is the next-to-expire. The back months have longer expiration dates. So the December options are the front-month options. Options expiring next March are back-month options.

    So what I'm suggesting is, for example, buying options with, say, 40 days remaining and selling options with, say, 70 or 100 days remaining - at a ratio that makes you vega neutral. Assuming that all strikes are approximately equidistant from the money, then the less time remaining, the greater the gammas and the less the vegas.
  9. I suggest this play ONLY because you are looking for a 'good-sized' move. You are right, it is a play with positive vega.

    When you get that big move, you want to own front-month options because they have much less vega and time value that longer term options. Sure you would lose on vega if the move were to the upside, but if you move 20+ points ITM, does it really matter?

    Finding a position that's comfortable for you is the goal. If you believe the near-term strangle is too vega rich, then it will not suit you.

  10. MTE


    The problem with a long straddle/strangle is that you make money only if the move is greater than anticipated by the market, if it's not then the long vega kills you.
    #10     Nov 29, 2008