gamma scalping (profit target)

[adamchubb]

If I do gamma scalping with a straddle and delta hedge with stock, I wonder what would be an appropriate % profit target (based on the initial straddle price and ignore any capital required for stock hedging)?

To be exact, i mean

- total scalping profit / straddle price

(I just want to know what would be a "decent" profit %, say 10%, 20%....). In that case, I also ignore any possible increase in straddle price due to increase in IV, minus theta.


Or, I would like to know if there is any better way to calculate % return on "gamma scalping".

 

[cvds16]

it's an art, seriously I am not joking, if it would be that simple, quants would just put on their pc's and rake in the money ... charts might help you there, or any other method for that matter but there is always a trade-off; there is no such things as a free lunch.

 

[gerr33git]

Quote from cvds16:

it's an art, seriously I am not joking, if it would be that simple, quants would just put on their pc's and rake in the money ... charts might help you there, or any other method for that matter but there is always a trade-off; there is no such things as a free lunch.

And thanks God, that would be the end for option market.
I target about 20% return for gamma scalping.

 

[jwcapital]

Unfortunately, there is no way to predict a profit (or loss percentage). Example: Suppose you buy 5 ATM 1175 put for 30 and buy 5 ATM 1175 call for 30. You are trading the ES (s&p 500 emini--as an aside this is what I've been trading for 6 years). So, your total layout is $15,000.00. You will not lose this entire amount in any case, so don't get scared). Now, with this strategy you want an advance or a drop and then a return to your strikes for max profit. Now, in this case, I want to become delta neutral (gamma scalp) when the delta of the portfolio is 50 (the delta of one ES future is 50). Now, as a rule, I only adjusted at end of day (4:14-4:15PM EST). From my experience, it only takes about a 15 point move in either direction to require an adjustment. I will use numbers from Dec trades. So, let's say the ES goes up 15 or so points and then reverts two times before taking off in an upward direction and not returning. By selling 1 ES 15 points higher, you lock in a $750.00 profit. Now it reverts and you buy it back. Then it advances 20 points by the end of next day, and you sell 1 ES again. You locked in a $1,000.00 profit. It reverts again, and you buy it back.

So, recap: you have made $1,750 on the ES trades, but you have lost on both options (about $1,000.00 because of time decay and changes in IV). So, at this point you have a total profit of $750.00. You can quit here if you are satisfied.
Next, the underlying takes off with no more reversions. So, you are selling an ES at 15 points higher, 30 points higher and 45 points higher. Now, you have locked in profits of $750.00, $1500.00, and $2250.00. BUT you have lost on the put (about $5250). But you have gained about $4500.00 on the call.
So, recap gains: $1750.00 from previous two reversions; locked in profits of $4500.00 from the ES; and $4500.00 from the ITM call option. Losses: $5250.00 from the put (which will go to less than a dollar real fast without any reversion). So, total P&L at this point is $5500.00. Looks like a 33% return. Now, if you exit the Friday before expiration, you will get back some of the initial premium you laid out..but remember you can just about count the OTM put as a total loser ($7500.00) and the ITM call will lose what little premium it has left (about $750.00 worth). So, you can see that if you hold the straddle too long it can become a loser real fast. Now just imagine the loss you take if there are no reversions--and believe me this happens.

Another point: Straddles are volatility/time positions--not positions to be traded..just rules to follow. Once you find yourself trading the positions, you will be in for disappointment and second-guessing.

 

[Trader13]

Quote from jwcapital:

Unfortunately, there is no way to predict a profit (or loss percentage). Example: Suppose you buy 5 ATM 1175 put for 30 and buy 5 ATM 1175 call for 30. You are trading the ES (s&p 500 emini--as an aside this is what I've been trading for 6 years). So, your total layout is $15,000.00. You will not lose this entire amount in any case, so don't get scared). Now, with this strategy you want an advance or a drop and then a return to your strikes for max profit. Now, in this case, I want to become delta neutral (gamma scalp) when the delta of the portfolio is 50 (the delta of one ES future is 50). Now, as a rule, I only adjusted at end of day (4:14-4:15PM EST). From my experience, it only takes about a 15 point move in either direction to require an adjustment. I will use numbers from Dec trades. So, let's say the ES goes up 15 or so points and then reverts two times before taking off in an upward direction and not returning. By selling 1 ES 15 points higher, you lock in a $750.00 profit. Now it reverts and you buy it back. Then it advances 20 points by the end of next day, and you sell 1 ES again. You locked in a $1,000.00 profit. It reverts again, and you buy it back.

So, recap: you have made $1,750 on the ES trades, but you have lost on both options (about $1,000.00 because of time decay and changes in IV). So, at this point you have a total profit of $750.00. You can quit here if you are satisfied.
Next, the underlying takes off with no more reversions. So, you are selling an ES at 15 points higher, 30 points higher and 45 points higher. Now, you have locked in profits of $750.00, $1500.00, and $2250.00. BUT you have lost on the put (about $5250). But you have gained about $4500.00 on the call.
So, recap gains: $1750.00 from previous two reversions; locked in profits of $4500.00 from the ES; and $4500.00 from the ITM call option. Losses: $5250.00 from the put (which will go to less than a dollar real fast without any reversion). So, total P&L at this point is $5500.00. Looks like a 33% return. Now, if you exit the Friday before expiration, you will get back some of the initial premium you laid out..but remember you can just about count the OTM put as a total loser ($7500.00) and the ITM call will lose what little premium it has left (about $750.00 worth). So, you can see that if you hold the straddle too long it can become a loser real fast. Now just imagine the loss you take if there are no reversions--and believe me this happens.

Another point: Straddles are volatility/time positions--not positions to be traded..just rules to follow. Once you find yourself trading the positions, you will be in for disappointment and second-guessing.

jwcapital, thanks for posting this great example.

A question for you on scalping the ES in particular:

You indicated you have been trading the ES for six years. I'm not sure if you meant directional trading or long gamma scalping of a delta neutral position. If you meant long gamma scalping (the topic of this thread), I'm very curious to know if your P&L is consistently profitable with the ES? I ask because option premiums tend to be higher on the indexes which works against you (higher theta). Also, in environments when the VIX is high, you have the risk of IV falling which may discourage you from opening a long options position altogether (unless you create a long gamma, vega neutral spread). These factors can make long gamma scalping of the ES on a continuous basis quite a challenge. Has this been your experience?

 

[adamchubb]

Quote from jwcapital:


Next, the underlying takes off with no more reversions. So, you are selling an ES at 15 points higher, 30 points higher and 45 points higher. Now, you have locked in profits of $750.00, $1500.00, and $2250.00. BUT you have lost on the put (about $5250). But you have gained about $4500.00 on the call.
So, recap gains: $1750.00 from previous two reversions; locked in profits of $4500.00 from the ES; and $4500.00 from the ITM call option. Losses: $5250.00 from the put (which will go to less than a dollar real fast without any reversion). So, total P&L at this point is $5500.00. Looks like a 33% return. Now, if you exit the Friday before expiration, you will get back some of the initial premium you laid out..but remember you can just about count the OTM put as a total loser ($7500.00) and the ITM call will lose what little premium it has left (about $750.00 worth). So, you can see that if you hold the straddle too long it can become a loser real fast. Now just imagine the loss you take if there are no reversions--and believe me this happens.

jwcapital, i don't quite understand the 2nd part "the underlying takes off with no more reversions". I guess the straddle would make money in that case (provided no change in IV and the underlying makes big enough movement).

 

[sle]

Quote from jwcapital:

Unfortunately, there is no way to predict a profit (or loss percentage).

Out of curiosity, how do you mark your vols for deltas - at implied, historical or expected?

 

[spindr0]

Quote from adamchubb:

i don't quite understand the 2nd part "the underlying takes off with no more reversions". I guess the straddle would make money in that case (provided no change in IV and the underlying makes big enough movement).

The objective of gamma scalping to to earn more from the scalping than you lose in time decay.

As long as the underlying gyrates (repetitive reversions), you book gains. If the underlying does nothing, time decay gets you.

If the underlying goes directional, you keep adding underlying which is a drag on the straddle's performance as you bleed out the delta generated by the straddle. If the underlying starts to channel, you're not scalping and time decay gets you. And IV change can make things better or worse.

In order to profit with gamma scalping, you're going to have to get some combination of things right - IV, timing of scalp adjustments, successful directional trading, and some underlying cooperation. As someone said earlier, if it was that easy, every trader with a mouse would be racking up gains.