Theta Decay & Delta Neutral without Calendar spreads?

Discussion in 'Options' started by chaunceygardner, Apr 1, 2011.

  1. Hi,

    I have been doing some research around Theta decay and I have a question around Theta decay.

    Assume the two following points:
    1) want to take advantage of Theta Decay i.e. your position increases as time progresses.
    2) However, I want to be as neutral possible on delta/gamma without using the underlying stock/futures i.e. I want to be Delta/Gamma neutral only using options.

    Is there any way to meet this two criteria without using Calendar spreads?

    I know that Theta decay differs based on ATM Versus ITM/OTM options but I was wondering what other strategies exist to meet the above two criteria without using Calendar spreads.
  2. sonoma


    Dismissing for a moment the issue of theta, can you tell us what type of risk you are willing to assume, given that you've momentarily eliminated minimal directional risk with your delta/gamma neutrality?

    Can you tell us why you want to avoid time spreads?
  3. Cant be completely delta/gamma neutral to isolate theta/vega. You can short an atm straddle which will be delta/gamma neutral but as soon as the underlying start to move, the position will be off balance and no longer neutral.

    You can pick a highly liquid option and let your system to constantly rebalance the short straddle by closing the old one and open new atm ones as the underlying moves x point away. But it will be like death by paper cuts with all the commission and tiny slippage paid. Maybe the pros can comment if any fund actually do this, i doubt it.
  4. sle


    Theta is gamma in reverse. Or, to be less cryptic, theta decay is the gamma gains you are losing(or gaining) at each time interval. So, no, you can't isolate theta from gamma. And with gamma comes delta, so you have to dynamically manage it. One of the reasons why people invented variance swaps was that they did not want to manage delta yet did want the exposure to realized volatility.

    My suggestion is to read filthy's awesome book, Volatility Trading, it goes through this stuff in detail.
  5. If you sell an ATM or just OTM vertical spread you may be close to achieving your goal without using calendar spreads.
  6. Thanks for your insightful replies sonoma, newguy05, sle & lowvoltrader

    the responses to your queries:
    Sonoma- We take a software/quant approach towards our options strategies and we have been running our analytics on various combinations of calendar spreads. I was wondering if there were other additional strategies we could run our analytics on. The risk we are willing to assume is volatility.

    newguy05- Selling a pure straddle is one way but as you mentioned, we have too many rebalancing risks and also we want to be flexible on the vol positions i.e. we want to be long vol/vega in some cases and the straight straddles are not flexible enough for that.

    lowvoltrader- a simple vertical spread (put or call spread) always has a directional risk. A short Iron condor also has a big delta risk on most combinations.

    Sle- I presume you are referring to the "Gamma Rent"/Alpa concept mentioned in Taleb's book. I have been researching on the linkages between Gamma & theta for sometime based on Taleb's book, Gary Norden's article and other sources.

    Its still unclear on how this process works. Would it be possible to explain (if you have time) with some numbers and example spreads on how this works?
  7. simonep


    Short ATM straddle is delta neutral but has very high negative gamma (you have a negative gamma both on the short call and on the short put) , which is "balansed" by very high positive theta (on both options)
  8. simonep


    There is ALWAYS a trade-off between theta and gamma.
    In other words, if you want to profit from positive theta, you CAN`T avoid negative gamma.

    You can consider diagonal spreads (vertical spread + calendar spread).
  9. you right i made a mistake in the post, straddle is balanced only on delta but one sided on gamma (and theta/vega). So it's not a good example.
  10. sle


    To be very-very precise, in many markets you could frequently structure a position where you are long both gamma and theta, however you are going to have a massive vega position which will become your primary risk.

    If you are doing vol arb, you absolutely have to read the book I mentioned
    #10     Apr 6, 2011