Gamma Scalping Question - Purpose

J

jonny1lot

Am I understanding correctly that the purpose of gamma scalping is to reduce the effects of having negative theta (increase duration) due to a long vol position?

Let's assume you are long a straddle, and you are expecting to make your move off of vol expansion, so you gamma scalp around your core position to reduce the effects of theta and increase duration?

I could also see the need for gamma scalping if you are long a protective put and you want to gamma scalp around that position to reduce the effects of theta.

Am I right in my thinking on this or am I off?
 
jonny1lot said:
Am I understanding correctly that the purpose of gamma scalping is to reduce the effects of having negative theta (increase duration) due to a long vol position?

Let's assume you are long a straddle, and you are expecting to make your move off of vol expansion, so you gamma scalp around your core position to reduce the effects of theta and increase duration?

I could also see the need for gamma scalping if you are long a protective put and you want to gamma scalp around that position to reduce the effects of theta.

Am I right in my thinking on this or am I off?
More...

Delta hedging perhaps not so important... the other value is if the option moves well into the money, and then back again before expiry, you won't have captured that vol and you'll lose the premium.

GAT
 
jonny1lot said:
Am I understanding correctly that the purpose of gamma scalping is to reduce the effects of having negative theta (increase duration) due to a long vol position?

Let's assume you are long a straddle, and you are expecting to make your move off of vol expansion, so you gamma scalp around your core position to reduce the effects of theta and increase duration?

I could also see the need for gamma scalping if you are long a protective put and you want to gamma scalp around that position to reduce the effects of theta.

Am I right in my thinking on this or am I off?
More...

No. The purpose of gamma scalping is that you believe the premium you paid for the options in terms of forecasted volatility in less then what you can earn through the realized volatility which manifests itself by the two way action in price. Options are priced in such a way that through continuous hedging should produce an expected value equal to the price of the option. If you are a buyer, you believe the expected value is higher then what is being priced in. In order to capture this though you need to have very low execution costs and preferably be an order flow provider.
 
well put Mav.... the "scalping" word i believe comes in because your bringing in credits to your account through trading the underlying as you neutralize delta... typically your bleeding and getting debited from the loss of premium in the options... you hope to make more from realize vol through the scalping process then lose in premium.. just as mav put.. alot of times they refer to letting your deltas run when you have a large size move and you just alot deltas to accumulated before you neutralize to lock in more variance/realized vol.. the more quantity and magnitude of moves you catch in this strat the more money you make.. There is calculus to it.. you will approach a optimum hedge frequency given a certain slippage and as well what your expected realized vol is... hedging technique is where the rub is i believe anyway.. and overtime you shouldn't make any money doing this in a fair market.. obviously i don't believe markets always price things fairly..
 
cdcaveman said:
well put Mav.... the "scalping" word i believe comes in because your bringing in credits to your account through trading the underlying as you neutralize delta... typically your bleeding and getting debited from the loss of premium in the options... you hope to make more from realize vol through the scalping process then lose in premium.. just as mav put.. alot of times they refer to letting your deltas run when you have a large size move and you just alot deltas to accumulated before you neutralize to lock in more variance/realized vol.. the more quantity and magnitude of moves you catch in this strat the more money you make.. There is calculus to it.. you will approach a optimum hedge frequency given a certain slippage and as well what your expected realized vol is... hedging technique is where the rub is i believe anyway.. and overtime you shouldn't make any money doing this in a fair market.. obviously i don't believe markets always price things fairly..
More...

Yeah I think what a lot of these retail folks are missing though is that scalping in and of itself does not generate the profits. It's only when you scalp after you bought options that are underpriced. If you overpay for the options, no amount of scalping by definition can help you. There is no free lunch. If you let your deltas run you are still making the same bet, that actual vol is > then forecasted vol.
 
ya true... I never did any quantitative studies myself as to the hedge parameters.. but i've read a few things about them.. my bet would be that what would show up is very close to the difference between retail slippage and MM trading costs..
 
I like what Maverick said...."if you let your deltas run you are still making the same bet..."

Bet being on a 1st moment basis -- "expected profit." Hedging or not doesn't change this.

The gamma trading is for the 2nd moment -- variance reduction. If you could trade continuously with no cost and no frictions, you could take the var to 0 and realize your expected profit every time.

Of course, we have to hedge discretely and it costs money. Cdcaveman is onto the right track...there is a good amount of research out there on transaction costs, discrete hedging etc. But the one solid relationship worth knowing is that P&L variance will decline proportionally with the square-root of gamma hedging frequency.
 
Gamma scalping, delta hedging... It seems like you need to understand what gamma is first?

An option's or option structure's delta exposure varies with moves of the underlying, that is, it has gamma. Option traders bet on volatility and not on the direction of the underlying so having this delta exposure is a nuisance they have to deal with. Because of this option traders hedge their delta exposures by trading the underlying.

If you are long gamma you will buy on downticks and sell on upticks. It's not more or less profitable than letting deltas run. It's just a way to reduce variance on your expected result. Read an option theory book like Sinclair´s
 
Also one final thought. If you do gamma hedge, it will be discretely, which means you are dynamically hedging a path-dependent position. If you dynamically hedge, it IS possible to lose more than the premium paid for the straddle. A risk worth knowing.
 
You must log in or register to reply here.
Back
Top