Gamma Scalping

G

gaussian

I've realized something about my trading I need to correct. My management inside of a trade is still rather poor. When I win, I make a correct choice, and when I lose I make a bad choice. However, there is a lot more inside of there I could be doing to manage the trade into either a net win, or a less painful loss. My strategy selection is generally limited to verticals and calendars so I'd like to improve that. I feel like I could significantly improve my profitability as a trader by cleaning up my position management rather than just leaving to the market to decide.

I figured a good place to start looking into position management (a thing so woefully missing from the literature) is gamma scalping and playing with the second derivatives in general. Something I've never really done before. I understand what they are but not really how to use them.

Would any of you guys mind throwing me some resources on it? The basic idea seems simple - in a long straddle you scalp gamma on the call side by selling the underlying to create a synthetic ratio. But I'd like to get some actual education on the subject and not just youtube promotion-masked-as-a-lesson kind of things. It seems too mechanical and simple. I prefer to do some reading before trying it out in the market. I figured you could do this on verticals as well, but I am really unsure as the only examples I have seen have been straddles.

Thanks!
 
I'd be glad to help, its pretty easy. You can figure most of it out just toying with a model. But we have to begin this by re-framing the way you see things.

"in a long straddle you scalp gamma on the call side by selling the underlying to create a synthetic ratio"

We begin by never saying things like this. That becomes, this --> "If you're long gamma, we sell the underlying to the upside to flatten out our delta"

Stop thinking about synthetic, stop thinking about ratios. Call side can still stay, (but I'd much prefer upside and downside) and what led to it must be removed. If you own a straddle you own 2 ATM options. Not a put and a call, as the moment you hedge, a puts a call and a calls a put. Forget they even exist, and don't remember they do, until you have to deal with expry.

All options above ATM are now calls, all options below ATM are now puts. There is no such thing as DITM. Forget they exist, until you need to test for early exercise, or again expry. You are hedged, the intrinsic is now irrelevant. The only thing you want to know from is extrinsic. That is all that matters.

If the above gets a thumbs up, we can move forward. Understand it is not something you can kinda apply, it's all in, or not. If you don't hear from me it's because I'll be out this morning, but will be around later. Once again this is easy. Understand it that is. Doing it :rolleyes:. Well, gamma hedging will teach you one thing, how to deal with never being right.

edit: I should add, unless your volumes are reasonable, you'll be dealing in decimal places, and this won't make any sense for you to apply.

Been wondering how many months I'd be reading an options forum before someone would talk about options. :thumbsup:

...and out of curiosity... link me to one of those videos...
 
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gaussian said:
I've realized something about my trading I need to correct. My management inside of a trade is still rather poor. When I win, I make a correct choice, and when I lose I make a bad choice. However, there is a lot more inside of there I could be doing to manage the trade into either a net win, or a less painful loss. My strategy selection is generally limited to verticals and calendars so I'd like to improve that. I feel like I could significantly improve my profitability as a trader by cleaning up my position management rather than just leaving to the market to decide.

I figured a good place to start looking into position management (a thing so woefully missing from the literature) is gamma scalping and playing with the second derivatives in general. Something I've never really done before. I understand what they are but not really how to use them.

Would any of you guys mind throwing me some resources on it? The basic idea seems simple - in a long straddle you scalp gamma on the call side by selling the underlying to create a synthetic ratio. But I'd like to get some actual education on the subject and not just youtube promotion-masked-as-a-lesson kind of things. It seems too mechanical and simple. I prefer to do some reading before trying it out in the market. I figured you could do this on verticals as well, but I am really unsure as the only examples I have seen have been straddles.

Thanks!
More...

I'd recommend Nassim Taleb's first book.

No, not Fooled by Randomness. I mean Dynamic Hedging, obviously.

GAT
 
You said a couple of head scratchers,but before I address them I'm like to know if you are always long gamma,how you chose that path and what your approach is as far as making adjustments.Specifically,is it somewhat systematised or Gut feel when it comes to adjusting delta..
 
@newwurldmn , @Wheezooo ;

While we're on the subject of hedging / dealing with pure vol, I have a question. If there's sufficient premium I'll usually have net short index vol. In a normal contango TS I'll go maybe 1-2 months out. Higher vegas are pretty straight-forward to me. If I want to reduce variance I can over-hedge my deltas. Also I can find some vol closer to spot to buy and manage gamma risk without paying too much.

My question is how to manage the vol when there's stress and the term structure bulges at the front and either gets flat or slightly backwardated in the middle. I want to get short in the very front here since the highest vol figures are there and also so I don't have too much vega rolling up the TS and creating a headwind. It's not so clear how to manage the risk though.

I can hedge more frequently but I still feel way more at the mercy of how price paths. I've had a lot of my best and worst days in these scenarios. Like when I'm short vol under spot, flat deltas and price gaps up overnight. Exposure drops so fast and leaves a big loss on the hedge. I'm thinking maybe I should under-hedge a little more than I normally would when I'm short right at the front? Also was thinking about carrying some extra long vol up top a little further back to mitigate a scenario like that. And it's usually cheaper too so if we go down instead it will provide a little PnL before the extrinsic is gone.

Any thoughts on how to conceptually approach this? I'm just a home gamer so apologies if I don't have some of the mechanics all the way correct :) This middling ground between calm market and solid backwardation is the furthest from my comfort zone but we've seen a lot of it these past few months.
 
Magic said:
@newwurldmn , @Wheezooo ;

While we're on the subject of hedging / dealing with pure vol, I have a question. If there's sufficient premium I'll usually have net short index vol. In a normal contango TS I'll go maybe 1-2 months out. Higher vegas are pretty straight-forward to me. If I want to reduce variance I can over-hedge my deltas. Also I can find some vol closer to spot to buy and manage gamma risk without paying too much.

My question is how to manage the vol when there's stress and the term structure bulges at the front and either gets flat or slightly backwardated in the middle. I want to get short in the very front here since the highest vol figures are there and also so I don't have too much vega rolling up the TS and creating a headwind. It's not so clear how to manage the risk though.

I can hedge more frequently but I still feel way more at the mercy of how price paths. I've had a lot of my best and worst days in these scenarios. Like when I'm short vol under spot, flat deltas and price gaps up overnight. Exposure drops so fast and leaves a big loss on the hedge. I'm thinking maybe I should under-hedge a little more than I normally would when I'm short right at the front? Also was thinking about carrying some extra long vol up top a little further back to mitigate a scenario like that. And it's usually cheaper too so if we go down instead it will provide a little PnL before the extrinsic is gone.

Any thoughts on how to conceptually approach this? I'm just a home gamer so apologies if I don't have some of the mechanics all the way correct :) This middling ground between calm market and solid backwardation is the furthest from my comfort zone but we've seen a lot of it these past few months.
More...

Can you make your own topic and not jack mine.
 
Magic said:
@newwurldmn , @Wheezooo ;

While we're on the subject of hedging / dealing with pure vol, I have a question. If there's sufficient premium I'll usually have net short index vol. In a normal contango TS I'll go maybe 1-2 months out. Higher vegas are pretty straight-forward to me. If I want to reduce variance I can over-hedge my deltas. Also I can find some vol closer to spot to buy and manage gamma risk without paying too much.

My question is how to manage the vol when there's stress and the term structure bulges at the front and either gets flat or slightly backwardated in the middle. I want to get short in the very front here since the highest vol figures are there and also so I don't have too much vega rolling up the TS and creating a headwind. It's not so clear how to manage the risk though.

I can hedge more frequently but I still feel way more at the mercy of how price paths. I've had a lot of my best and worst days in these scenarios. Like when I'm short vol under spot, flat deltas and price gaps up overnight. Exposure drops so fast and leaves a big loss on the hedge. I'm thinking maybe I should under-hedge a little more than I normally would when I'm short right at the front? Also was thinking about carrying some extra long vol up top a little further back to mitigate a scenario like that. And it's usually cheaper too so if we go down instead it will provide a little PnL before the extrinsic is gone.

Any thoughts on how to conceptually approach this? I'm just a home gamer so apologies if I don't have some of the mechanics all the way correct :) This middling ground between calm market and solid backwardation is the furthest from my comfort zone but we've seen a lot of it these past few months.
More...

No specific algorithm you can follow. It depends on your view of what will happen next.
 
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