I'm trying to choose between implementing a strategy using the ES and using SPY options. I want the option contract with the tightest spread and a delta of around .83, so I can buy 6 of them for every ES contract I would buy if I were to implement it in the ES, so that I've essentially got 500 "shares" of the SPY to make up a "synthetic" ES contract when I enter the trade. I'm leaning toward SPY options because I figure that when I am right, gamma will kick in and raise the delta over the time of the trade (average winner and loser is around .7 SPY points) and when I am wrong, the reverse will happen as the option gets more out of the money. Looking at the current SPY option series, the gamma on the call which most closely matches that profile is ~3% and the put's gamma is ~6%, so it seems like I'd be getting an extra 2% (.7 SPY point move on average X ~3% gamma) equivalent SPY shares for a long trade (like getting 10 shares' profit for free) and about 4% for a short trade. Am I missing anything big that invalidates this analysis?
True, but in this situation, I think the relevant comparison is the gamma for a high-delta option vs. the complete lack of gamma in the ES. You might be on to something in that I should compare the lower delta strike prices to the higher delta strikes to see which is the best way to construct the equivalent of 500 SPY shares/1 ES contract and would that tradeoff of delta vs. gamma be better for me over the average price range of the trades. I looked at the higher deltas first because it would take fewer contracts thus keeping trading costs lower, but I haven't looked at that in detail.
Maybe I'm misunderstanding what you're trying to do, but if you buy high-delta (ITM) calls and you're "right" (underlying goes up), then the underlying is moving away from your strike and your gamma goes down, not up. Same if you buy high-delta (ITM) puts - if the underlying goes your way (down), your gammas shrink. If you buy OTM calls, then you get the gamma effect you're looking for - gamma increases as the underlying goes up and decreases as it goes down. To balance that out however, keep in mind that as gamma goes up, so does vega. And as the underlying goes up, IV goes down, losing you money on your (ever increasing) vegas. If the underlying goes down, IV goes up but - alas - your vegas are shrinking. If you buy OTM puts, that same phenomenon works to your advantage. So you can see the many advantages of buying OTM puts over buying OTM calls. That's why they're more expensive (higher IV).
I was not clear that I'm not looking for gamma to go up, just to have some positive impact so that the synthetic 500 SPY shares/1 ES contract is more profitable over the same price range on winning trades and less unprofitable on losing trades than an actual ES contract, where none of the greeks are in play. But, if I understand your point about vega, it would negate the gamma impact so that perhaps the better way to think about the strategy implementation is to buy the deep in the money calls when my trade is on the long side, to minimize the impact of vega, but to buy out of the money puts when I think the market is going down, which will enhance the impact of vega. Is that interpretation of your comment correct? I'm also aware that what I'm trying to get at may not be possible at all because the market is too efficient and all of these variables net out to nothing and 500 SPY shares, 1 ES contract and the delta equivalent of 500 SPY shares constructed from multiple options contracts are all equally profitable or unprofitable over a range of .7 SPY points, so that the best implementation of the strategy is to go with whatever instrument costs the least to trade or has some other benefit, like being traded almost 24/7.
You seem to be leaning toward the use of options over underlying because by buying options you acquire gamma, which as you say means that as the underlying moves, the delta changes in the direction you WANT it to change. True, but keep in mind that you PAY for those gammas. That's what the premium (cost of option over and above ITM value) buys you. Another way to look at it is that you rent those gammas. The rent you pay is the theta. So in the world of greeks, you pay the seller a daily rent of theta for gamma. Or if you're a premium seller, you rent out gammas at a daily rental rate of theta. So the question is not "is being long gamma good?" Of course it's good! That's why you pay for it. The only question is whether or not the rent you're paying for those gammas is high or low. Good value for the money or poor value for the money. I don't see you taking that critical factor into consideration. Buying gammas means the same thing as buying volatility (the volatility of the underlying). So if you are paying less for that volatility than it is theoretically worth, then you are paying an IMPLIED volatility less than the ACTUAL volatility. See how it all fits together?
I guess I'm implicitly assuming that I'm getting a good value on average, so long as my winning trade percentage is higher than my losing trade percentage. If the underlying moves against my directional preference, I got a bad value for renting gamma, but if if moves in my direction, I got a good value. I have to assume the seller believes that selling for the current option price is a good deal relative to what the future price will be and that sometimes the seller will be right, but most of the time, I'm right as a buyer, so long as I win more often than I lose. Since my holding time is typically less than two full trading sessions, I don't tend to pay much attention to theta. That might be too simplistic.
You're confusing deltas with gammas. The value you get for your gammas is the same whether you make money or lose money. It's the delta that determines whether you made a good directional bet or not. Nothing to do with gammas. Let's say you bought xyz 120 calls such that your position delta is 1.00. xyz goes up 1 point. Without gammas (that is, had you instead bought 100 shares of xyz),you would have made $100. But because you are long gammas, you've gotten longer deltas as xyz rises and you made $110. Now imagine that you instead bought the same number of 120 puts such that your position delta was -1.00. Again, imagine xyz goes up 1 point. Without gammas (had you sold short 100 shares of xyz), you would have lost $100. But because of the gammas in those 120 puts, you lost only $90. In both cases, the gammas you bought gave you a $10 advantage over having the identical delta position in the underlying xyz stock. So the gammas you bought - which are identical in 120 puts and calls - gave you the same bang for your buck in either case. Said otherwise - if the theta you lost on those options (the rent you paid for those gammas) - in either the call example or the put example - was $10, then you paid exactly a fair price for the options. If the theta was $9 you got a good deal for the options - even in the put example where you lost money - because you lost $10 less than you would have lost with the same delta position but without the gammas.
If you are really looking for some kicker try the weekly options. This is where you will find some gama^3. sanglucci dot com is a great place to learn and follow. (no affiliation, just started looking at it couple weeks ago). Here are the weeklys avail http://www.cboe.com/micro/weeklys/availableweeklys.aspx