Optimal Approach to gamma scalping

Discussion in 'Options' started by ashc48, Feb 24, 2004.

  1. ashc48


    Does anybody know of a systematic approach to optimally scalp gamma when long a straddle?

    Say I buy an ATM call and put ( straddle) on stock XYZ. My goal is to trade the stock in a delta neutral way to take advantage of the long gamma and cover the daily time decay at a minimum. Are there any simulation approaches that someone could run on XYZ , that would provide some guidance as to the most desirable increment on each side of the stock price to go long and short? It seems to me that taking into account the average true daily range and beta of the stock – variables that are not taken into account when options are priced using B-S – there should be some optimal range for scalping. I realize that the actual price history of the stock going forward is not known but may be there is something better than totally discretionary.
  2. I prefer to use a GARCH model, or simply define stat-volty of the underlying and build a discrete hedging model based upon 1,2 and 3sigmas of the daily or weekly stat-volty to pick my hedging points. That's a place to start.

  3. From which provider do you collect these historic data on a daily or weekely stat?
  4. Maverick74


    This may not be the scientific answer you are looking for but I will give you the real world perspective. The way people trade gamma has normally something to do with the type of underlying trader you are. For example, some people are trend traders, i.e they buy the highs and sell the lows, and other guys are bottom and top pickers. I believe in order to be a good long gamma trader, you should probably be the guy that likes to buy the lows and sell the highs. It requires a certain type of feel to do that.

    The converse is true for short gamma traders. If you trade with the trend very well then you would probably be a better short gamma trader. I think the mistake a lot of people make is they are trend traders and they try to trade long gamma which forces them to try to call tops which they may not have a good feel for. So regardless of what kind of quantitative approach they take to scalping, it goes against their nature. Same is true for traders that like to bottom and top pick. If they have short gamma, it's not really a good combination.

    One of the things you will learn about trading, is that people who are successful at it, tend to trade in a way that is congruent with their personality.
  5. Great post mav. Makes a lot of sense.
    If only I know which kind of "trader" I am.... oh well the journey to self discovery continues.....
  6. to answer the original poster, you can make adjustments after regular time intervals, e.g. every day or every week, or you can adjust after a certain number of deltas are produced. if you desire to be as delta-neutral as you can, more frequent adjustments will have to be made. the other way is to wait until the "delta factory" produces a certain number of deltas either way, e.g. +/- 200,300, 500 -- whatever threshold you are comfortable with. then you adjust against the neg deltas by buying stock or shorting the positive deltas. for example, you buy a straddle in xyz, initially about delta neutral since the stock was at the strike when you bought it. one week later, the straddle has produced -300 deltas, so you buy 300 shares and neutralize. the stock returns to near the strike, you sell your 300 sh and wait again for your delta threshold to be hit. the stock rallies and produces 300 deltas, so you short 300 shares etc. etc. if you can pay for, (or at least greatly reduce the price of) the straddle doing this a few times, then you can stop the scalping and ride out straddle and give it a chance to show you more profit on its own.

    the problem of course is that scalping against the straddle pre-supposes that the stock will mean-revert toward your center strike. if it does not cooperate and keeps going away from the strike, i.e. begins to trend strongly, more and more deltas are produced, you keep adjusting against them, etc. (until the gamma of the straddle finally goes to zero), no more delta adjustments can be made and you find yourself holding a totally delta neutralized _loser_.

  7. Mav,

    What an insightful post on so many levels!
  8. ashc48


    Thanks to all you guys for sharing your time and experience with us newbies here. Very useful info.
  9. I may be missing something here, but it would seem that trying to gamma scalp a long stradle sounds a bit dangerous. My reasoning here is that when long a stradle, you have all the negative theta of both legs (long call & long put), but your gammas & deltas are low (call deltas off-set put deltas).

    When scalping long gamma, you want as much gamma as possible with as litle theta as possible. Therefore, trying to scalp a long stradle seems to be the worst of both worlds (small gamma & delta, yet with all the nasty theta).

    For scalping long gamma, I would suggest a long call OR a long put for the option leg.

    If you must create a "complex" option leg for long gamma scalping, it just makes sense to build the option leg so that you are reducing theta proportionally more than your are reducing gamma.
  10. I knew that this handle ringed a bell...Well , maybe it's your lucky day and one of US "cretins" can enlighten you

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    #10     Jul 1, 2007