Hi guys, I have been reading up on options and I see many people recommending to stay Delta neutral. Is it possible to stay relatively Delta and Gamma neutral, and only risk Vega and Theta? What are the strategies for this type of trade? Thanks!
you could do this in a kind of butterflyposition strangle where you oversell the extremes and then hedge your delta as the market starts to move. However it might be that you need to adjust your position as time moves on if you want to stay gamma neutral. This kind of position is what smart option market makers are aiming for. However for them it's not so much a position but a continuous process.
I believe that nuetraility is achieved for an instant but once that instant passes and the market or underlying moves the theoretical greeks change and you are off balance. You can minimize effects of certain greeks but again for how long? I think the better question is to understand which strategies benefit from movement in certain greeks and take it from that viewpoint. For example, as mentioned above an ATM fly is initially delta neutral and is sensitive to Vega. You can trade Vega in this approach. Of course if the underlying makes a larger move than expected the FLY starts to become delta biased. However you can still do better attacking a greek via a position than working so hard to neutralize it IMHO.
(a) You can find a garden variety of linear combinations that would be neutral to any combination of greeks (almost). It's even possible, in the world of skew and term structure to find combinations that have both positive decay and positive instantaneous gamma (e.g. long shorted dated long vol and short longer-dated OTM put skew). That does make it risk-free over long moves. (b) In the end, you are making a statement that something is mis-priced (anything, from the underlying to the obscure corner of the volatility surface) and looking for the best way to express that view. Sometimes the view will be best expressed in a way that's completely neutral (e.g. you think the wings are rich and gamma is cheap, you trade a vega-neutral fly) and sometimes it makes sense to keep some of the tangential risks unhedged. I think a lot of people confuse greeks (i.e. risk parameters) with the sources of alpha.
Welcome. I gather from your question you are not a professional. As a mom and pop amateur retail, I find it easier to trade directional than neutral. For me, delta and gamma hedging were expensive as commissions and slippages ate up whatever profits I could generate so I gave up on the idea. The only hedge I do now is collar, after I run up gains but not ready to exit and for tax planning. Vega trades are difficult for me, I just do not have the detail models and math skills, so I leave that to professionals.
you could start with overselling the tails in a butterfly; with a straddle or strangle you'd have to be buyer of the tails making it in to a butterfly too ... and then keep on adjusting (most likely as a market maker) with the flow you receive from the market ... that was the old way to play it ... the markets have become more perfectly priced so I am doubtful you could make this kinda strategy work given the current market circumstances. My rule was if anything was getting too big in the greeks I tried to compensate for that by adjusting my position in the market and be more favourable of buying certain combo's of options with size. I was not afraid to be in the market for 100 lots in several series if that seemed necessary. Like I allready said cancellation costs have killed my business overnight. So ideally you'd need to be a market maker nowadays but with the given small spreads you'd have a hard time doing this in practice. It's no coincidence that IB sold Timber Hill ... that fact alone should tell you something.