ParisJOM, I'm a long gamma trader and I engage in buying straddles all the time with very good success. It's my bread and butter plays. However, you're absolutely right. Not only it's dangerous if it's not done right, but it can ruin your entire week, month, etc... not to mention your state of mind. That's why your position must overpower theta with a large dose of volatility which is the only time I will step up to the plate.
I'd like to revisit this question since I too am interested in this strategy. I understand the concept of gamma scalping and I think, its advantages and disadvantages. I'd be interested in hearing about its practical application rather than the theory. For example, with a good move in the underlying, the delta of the near month straddle will move more than that of the 2nd month so that's a vote for the near month. However, time decay is the enemy so you don't want to be long the straddle near expiration. So what's the ideal time period for the straddle? Buy when one month remaining and roll to 2nd month when two weeks remaining? If I have one delta neutral straddle, what's a good rule of thumb for where to adjust with stock? 20 delta? 30? 50? I realize that the ideal adjustment level is where the stock peaks or bottoms and then reverses, but not knowing where that is, at what point would you begin to adjust? IV is also a factor. Ideally, buying lower IV and catching an expansion is a good thing. But suppose I'm interested in establishing a new straddle but IV has risen recently and I'm concerned about subsequent contraction. Is the answer as simple as pass on it? Or is there a way to set something up with some short delta and still be able to gamma scalp (another initial option strategy)? Or suppose that I bot the straddle and IV has risen. Would you contemplate selling some premium on one side - converting one side to a vertical but making sure not to lock in a loss? I realize that this mutates into another position with different risk/reward parameters. Just asking if there are some not so obvious benefits or drawbacks. I know, lots of questions. Feel free to answer any that you can as well as telling me what questions I should be asking (g). Also, are there any good web sites or books that go into greater detail? TIA
Spin: one approach that I have tested only 2 times ( so take with proverbial grain of salt) is going long the straddle and delta neutral on the stock when IV is relatively low and expected to rise. This is more delta scalping but may be applicable Case in point was COSTCO (COST). With the stock at $57 and change after a little drop on same store sales weakness in September I bought 20 OCT $57.50 straddles and shorted stock to get delta neutral with earnings due just before OCT expiration. Since earnings were coming out in a few weeks the stock was a little rangebound and I was scalping deltas in increments of 100 or looking at the chart for breakout of consolidation. Stock moved to 61 so I would short every 100 - 200 deltas and when it dropped in price I would take some profits on the shorts as it moved back lower. It was little here and there but at least it was something while stock was meandering. IV pumped up a little bit as earnings approached helping the straddle and when earnings finally came out, the stock gapped and ran to $70 where I closed everything. The max risk on the position was about $9k at the open and I whittled it down to $7k with delta scalps here and there and closed it all for $2,800 in profit (I am doing these small to understand them better so the % is probably more relevant). SO the return was decent given the max risk. Of course there is some discretion as to when to scalp and as the stock started moving higher abvoe $61 I did not add more shorts since the trend was pushing higher into earnings (risky I know). But bottom line COST had IV lower than SV, had earnings coming in a few weeks which would be the catalyst to hopefully move prices and also hopefully improve IV leading up to earnings. COST will not get the IV pump like GOOG before earnings but any increases help the long straddle. Also a stock like COST has smoother moves than a GOOG or main tech stock so it was easier to monitor and look for right times to scalp. I only did this twice, both times on COST so naturally this is not a detailed approach fully tested. But I liked the parameters getting in, especially on stock with history of moves but not too jumpy either where it is hard to hedge regularly. Hope that helps a tad...
Thanks for the example Coach. I would think that if you have a long straddle, then you would ideally want to exit at the peak volatility level, meaning before earnings/event occurs, unless you expect a very large move post-event. Also, realizing that hedging is a large part art and personal preference, if using a certain sigma level or delta to hedge, is there a general rule as to %of delta exposure to reduce. Meaning 33%, 50%, 100%.
Phil, Thanks for the detailed reply and including a real world example. Everything you wrote made sense. LOL... meaning, I understood it! These things make sense on paper but it takes awhile to get a feel for them. I've done a few gamma scalp positions and all worked out modestly. But so far, I'm flying by the seat of my pants and trying to pick up some of the ideas that people get from experience. I suppose I'm just going to have to do what I've done with other new strategies - keep at it slowly until it gets into my comfort zone. Thx again. Spin
That is pretty much what I did with COST, took a small position and a max risk I can live with and see how it went. This one went really well given the run up into earnings, I doubt they will all work this way. But if I get a good IV situation, catalyst and sufficient time and a good price history to work off of, I am inclined to try it again. I will let you know if I open a new one and we can track it and vice versa at you know where. I dont think I would dedicate the portfolio to it but if oppty arises for one, why not...
I was targeting exiting at a point right before earnings when vols peak but COST recent history kpet me in as I was looking for a move on good or bad news. I got a much bigger move than expected so it worked well but in other cases I may need to go position by position to determine if I should bail or hold through the news.