Gamma determination

Quote from Profitaker:


Gamma is what we buy and sell. It's everything.

Using delta as a measure of risk is next to useless.
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That's just WAAAAAY oversimplified. Convexity is one risk to be managed, but hardly "everything".

Frankly, delta is extremely important to me. I continually compute the cumulative delta and beta-adjusted delta of my entire equity option portfolio. If I'm too loaded up on delta positive positions, I'm taking excessive risk from a broad market pullback.

Gamma is managed tactically, but my delta risk is what I'm strategically trying to minimize.

This last month, Vega risk is what kicked my butt, not gamma. Take a look at Wheat's IV chart. Historically averaging around 25% IV, it spiked to 60% this month. That hurt--gamma and delta had nothing to do with it.

Simplifing any complex position to "one" risk factor may be closing your eyes to scaaaary stuff. :-)
 
Fully Articulate

My main strategy is selling front month options, so the vega risk is of much less concern (to me) than Gamma. Remind me not to trade wheat ! I suppose it depends on what markets you trade and how you trade it, as to how you see the risks.

I agree that delta is important, but taken in isolation it’s (almost) meaningless as a measure of risk. For example, a delta of + 0.60 with 30 days to go before expiry is much less risky than a delta of + 0.60 with 2 days to expiry. The Gamma difference in that example is huge. I know you know this, just posting it up for discussion.

Beta adjusted Delta....Hmm....When you get a minute....what is it ? and why is it important ?
 
Quote from Profitaker:

My main strategy is selling front month options, so the vega risk is of much less concern (to me) than Gamma. Remind me not to trade wheat !
Ha! Who figured wheat would hit 10+ year highs in just a few weeks. It looked oh-so-stable when I got in. :-)

Gamma is certainly the risk new option traders have virtually no understanding of. But convexity appears in a variety of markets, particularly in fixed income. It's also the risk the unaware are most likely to get hurt by.

One of my wheat legs was sold at 5. I bought it back at 63. When I sold it, delta was somewhere around .1. ".1" certainly did not measure my risk in that position. :-)

Beta adjusted Delta....Hmm....When you get a minute....what is it ? and why is it important ?
I trade a variety of markets, but in equities, I believe the market is almost exclusively "emotion" driven rather than fundamentals or technicals. There's a great story that Alan Greenspan used to take bets with other Fed governors about what the markets would do in reaction to their interest rate changes. Greenspan says he had a 20% success rate. To me, that means the big money is pretty random.

So, when I do directional option trades, I believe certain equities will outperform the broad market, or underperform the broad market. The problem is, how do I factor out the "broad market"? I don't really want to make money only during up markets, for example.

So, I "invented" (although I'm sure I'm not the first) this idea of beta-adjusted delta. If a stock has a beta of 1, it will move an equal amount to the S&P 500. A beta of 2, and it will move twice as much. So, overall, if my portfolio is loaded up with bull spreads and calls on high beta equities, my beta-adjusted delta will be extremely positive. This means I'm not doing a very good job factoring out the "broad market". In essence, I can only make money if the S&P goes up.

Tracking my portfolio beta-delta forces me to look for underperformers, or at least to buy hedging puts against the market in the worst case. In the end, I'd like to make money no matter what the S&P does.

Beta-Delta = equity's beta * leg's delta

I hope that all makes sense.
 
FullyArticulate

I does make sense, thanks.

But not sure of it's benefits though unless you trade individual equity options against the index options of which they form a part? Even then, Beta's are notoriously unreliable.

Need to read you post a couple more times....
 
Quote from Profitaker:

But not sure of it's benefits though unless you trade individual equity options against the index options of which they form a part? Even then, Beta's are notoriously unreliable.
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In my case, beta is always measured against the S&P. Although that's simplistic, it's easier for hedging purposes (and has worked reasonably well for the last few years).

Beta can't really be "unreliable", it's just a statistical measurement, not a predictor. In my case, it's based on the last 20 trading days. Why 20? It's just a number that has worked for me. But, since it's a sliding measurement, every day a new beta-delta is computed. In general, the skew is extremely small, I've found.

Basically, I'm trying to do what all the pairs trading guys do, but with an entire portfolio, and without needing to find correlated stocks. If you're long DE, short CAT, for example, you're factoring out the "broad market". If the S&P dives 7% overnight, you really don't care--you'll lose on DE, but you'll make it up on CAT. You're just looking for DE to outperform CAT, even if both of them run off a cliff--you just want DE to fall less far. :-)

As for beta-weighting other greeks, I couldn't really wrap my mind around what beta-gamma really meant to me (and, in general, my directional trades are gamma positive, so it didn't seem to matter much).
 
Quote from Profitaker:

FullyArticulate

I does make sense, thanks.

But not sure of it's benefits though unless you trade individual equity options against the index options of which they form a part? Even then, Beta's are notoriously unreliable.

Need to read you post a couple more times....
More...

The benefit of beta weighting is that when you have a number of positions across various underlyings you cannot just add up the greeks to see your exposure to the overall market moves. So beta weighting is a way of bringing all positions to the common denominator. Btw, you can beta-weight against anything, it doesn't necessarily have to be an index. You can have positons in say NEM, GG, INTC, GOOG and OIH and want to beta-weight all of them against OIH.

You're correct, though, in saying that betas are not very reliable and don't work on short time frames, but I guess you could argue it's better than doing nothing.
 
Quote from FullyArticulate:

...As for beta-weighting other greeks, I couldn't really wrap my mind around what beta-gamma really meant to me (and, in general, my directional trades are gamma positive, so it didn't seem to matter much).
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Yeah, beta-weighting other greeks doesn't really add much value, but I thought I'd just mention it as it is possible.
 
Quote from MTE:

Btw, you can beta-weight against anything, it doesn't necessarily have to be an index. You can have positons in say NEM, GG, INTC, GOOG and OIH and want to beta-weight all of them against OIH.
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This is a really good point. I spent some time switching all of my beta weighting to NDX (since I'm generally trading nasdaq stocks). I found it to be a tradeoff (like all things in trading). I briefly dabbled with beta-weighting against the appropriate index (NDX for tech stocks, SPX for large caps, RUT for small caps), and got interesting results, but hedging got really complicated.

Now, if I'm beta-delta positive .5, I can buy an ATM put on the S&P and be done with it. It's not perfect, but it's not bad!

GG, NEM, INTC, GOOG, and OIH, eh? :-)

Speaking of pairs--GG/GLD is an interesting spread.
 
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