delta-gamma neutral

[dmo]

Quote from mynd66:

Now thats really facinating, I had no idea how things really work for a MM. Not to get too off topic but do newly hired MM's have a high fallout rate? I mean it seems like a couple wrong moves and you could really be wiped out. Or is there a world of preliminary requirements before you are given the responsibility? Pretty cool stuff though.

I'm going to read what you wrote again and just re-think the trade. I'm getting there.

The world has changed a lot since I was on the floor. Like some others in that pit at the time - including Charlie Cottle and Shelly Natenburg and Jim Bittman - I traded my own money exclusively. I was totally alone, totally on my own. I had to write my own option analysis program, and my own program to print up theoretical value sheets, as nothing was commercially available at the time.

As a result, I think we had a unique opportunity to learn every aspect of option trading and position management - one that may not even exist any more. Today everyone is a cog in the wheel. There's the IT dept. and the risk management department and the quants and the floor traders. Each of them sees just their little corner of the world, and I don't think any of them can see the whole global picture as we independents were able to. I think that's why so many of today's well-known option teachers and authors came out of that pit and that era.

A very small percentage of independent locals made it past the first year because, as you say, a few small mistakes could wipe you out. It was the last of the great democracies. Anybody could try it, you could start with very little money (I started in 1984 with $15,000 in my account), and the only thing that determined "who you were" was your own ability to succeed. Ex meat-plant workers traded alongside cops and firemen and lawyers and ex Chicago Bears.

Now of course it's totally different. You can only really get in by getting a job with a firm, and you can only get a job by having certain very narrow qualifications.

 

[ammo]

i was a directional trader so i wasnt too up on the greeks,but as a new options trader,scalp,box tradder, one of the rules of thumb was if you wer long a 10 lot at 3.5 of an option and you wanted to get delta neutral over lunch,you could sell 5 of the bigger calls for 7 and you would temporarily be protected,dmo will tell you there is a lot more to it than that,he's right, but dollar for dollar was good for short term

 

[dmo]

Quote from ammo:

i was a directional trader so i wasnt too up on the greeks,but as a new options trader,scalp,box tradder, one of the rules of thumb was if you wer long a 10 lot at 3.5 of an option and you wanted to get delta neutral over lunch,you could sell 5 of the bigger calls for 7 and you would temporarily be protected,dmo will tell you there is a lot more to it than that,he's right, but dollar for dollar was good for short term

Ammo, were you an equity option MM? When I hear someone mostly think in terms of spreading options against other options, that's usually the sign of someone who cut their teeth on equity options.

In options on futures you have the incredible convenience and luxury of having the underlying - the futures - right there next to you, and the ability to instantly go long or short any number in order to get delta neutral. I find that changes the whole game, which is why futures option traders and equity option traders usually have a very different approach.

 

[ammo]

yea ,oex,and you could sell the big spx against it at $250 k a 1 lot, It was trading around 250 at the time,so 95% of us just hedged with options against options

 

[xflat2186]

DMO in equity options you could buy or sell the underlying with no hassle. I made markets in individual equity options, index options, options on cash currency options on currency futures... pretty much most everything listed except the interest rate products and the agg commodities. Yea in the old days it was easier when the futures traded in the pit next to you. Really since the early 1990’s you could trade the underlying stock or basket for indexes from a hand held and heck by the late 1990’s early 2000’s most the equity options MM’s were not much more than box monkeys who just spit out the markets they were sent on their screen. I am sure the equity options floors are ghost towns now since its mostly electronic.

Interesting thread… and by the way I would always take the other side of this trade for edge why the heck not?

 

[dmo]

Quote from xflat2186:

DMO in equity options you could buy or sell the underlying with no hassle. I made markets in individual equity options, index options, options on cash currency options on currency futures... pretty much most everything listed except the interest rate products and the agg commodities. Yea in the old days it was easier when the futures traded in the pit next to you. Really since the early 1990’s you could trade the underlying stock or basket for indexes from a hand held and heck by the late 1990’s early 2000’s most the equity options MM’s were not much more than box monkeys who just spit out the markets they were sent on their screen. I am sure the equity options floors are ghost towns now since its mostly electronic.

Interesting thread… and by the way I would always take the other side of this trade for edge why the heck not?

Xflat - maybe the fact that Philly started later than the CBOE actually gave it an edge - in that traders there "grew up" with the underlying readily available. When the CBOE started in the 70's, doing the underlying was a pain and as a result the culture and trading style there developed around option-only spreads.

I've noticed that the few times I've met and talked options with equity options traders from Philly, I was surprised that they see options very much the same way as Chicago futures-options traders. It struck me, because I always notice a big difference in the culture and option trading style of CBOE guys vs CBOT.

 

[black diamond]

Quote from dmo:

I'm talking about doing this spread at a ratio that makes you gamma neutral, vega neutral, and theta neutral. In a nutshell, premium neutral.

Hi DMO, can I ask you a silly question? I am not familiar with the term premium neutral, I was confused at first because I thought it meant dollar premium sold = dollar premium bought but from your post I can tell this is not true.

So is premium neutral just another way of saying instantaneously delta, gamma, and vega neutral? Do you literally get premium neutral by calculating and neutralizing these three exposures or is there a rule of thumb to get you there? Thanks!

 

[black diamond]

Quote from mynd66:


Honestly I am confusing the shit out of myself and I have to stop looking at this for a while I've been stuck on this since yesterday. I don't understand why bother neutralizing gamma when you can just keep tabs on the delta and adjust accordingly. Why couldn't I originally (prior values of delta) just forget about gamma and buy 100 calls and sell 150 puts, no shorting the underlying and still neutral...and then just keep tabs as I would here?

One thing I can add to DMO's answer - it is a lot easier to keep tabs on delta if gamma is low or neutral. Delta hedging can be tough, more gamma makes it tougher. The other stuff is true (the parts that I understand anyway) but this is a first order effect that shouldn't be underestimated.

 

[dmo]

Quote from black diamond:

Hi DMO, can I ask you a silly question? I am not familiar with the term premium neutral, I was confused at first because I thought it meant dollar premium sold = dollar premium bought but from your post I can tell this is not true.

So is premium neutral just another way of saying instantaneously delta, gamma, and vega neutral? Do you literally get premium neutral by calculating and neutralizing these three exposures or is there a rule of thumb to get you there? Thanks!

Premium neutral has nothing to do with delta. It means gamma, vega and theta neutral (maybe that's what you meant). "Long premium" means long gamma, long vega and short theta. "Short premium" means short vega, short gamma and long theta.

Short, long or neutral premium has nothing to do with the dollar amount of options you are long or short.

Again, this "shorthand" only really works if all your options have the same expiration. If they do, then you need only calculate one of those 3 "premium" derivatives (usually gamma) and if that's neutral so are the two others. But no, I don't know any quick rule of thumb. You just have to use the math.

If you have options in different months, the relationships between those derivatives break apart. The more time left until expiration, the greater the vega, but the lower the theta. So to describe your position you would have to specify its greeks individually.

 

[dmo]

Quote from black diamond:

One thing I can add to DMO's answer - it is a lot easier to keep tabs on delta if gamma is low or neutral. Delta hedging can be tough, more gamma makes it tougher. The other stuff is true (the parts that I understand anyway) but this is a first order effect that shouldn't be underestimated.

Right. And to take it a step further, it's a lot easier to keep tabs on gamma if there's a lot of time remaining until expiration. As expiration approaches, gamma becomes more and more "volatile," and changes in response to every move in the underlying.