Guidelines for Theta/Vega and Theta/Gamma Ratios in overall Portfolio

[JackRab]

The guy has infinitely more experience than I do so I won't claim to speak for him, but I think the argument is that it's a good consolidated risk measure in the sense that you collect theta for selling gamma risk. It might take 3x the position to achieve the same theta farther out, but then it takes 3x the position to achieve the same gamma risk too. Raw position size is clearly not the only measure of risk...

No, that's where you/he is wrong. Gamma will be almost the same with 3x position size...

That's what I mean, it's not as clear cut as you think it is... and therefore, as a risk metric... theta on it's own is almost useless... same goes for th/gamma ratio as a risk metric.

And if I throw in IV shifts... it will be even harder to understand why you have a loss/win...

With options, best is to know what scenario's can happen and use that as a starting point. Then go down the metrics... and then you will better understand theta/gamma/vega.

 

[monkeyjoe]

If anyone's wrong on the interpretation, I assure you it's me. I agree with everything you said... Obviously this is just a way to know you have too much gamma risk on, definitely need to also consider stress testing, vega risk, etc.

...

No, that's where you/he is wrong. Gamma will be almost the same with 3x position size...

Maybe we are talking past each other. Can you clarify what you mean by this?

Here's what I meant:

An ATM call option 30 days out costs about 3x as much as the one 3 days out, but has about 1/3 of the theta and about 1/3 of the gamma. So, the same gamma risk at 30 days would require 9x (not 3x) the position size as at 3 days, and it would have the same theta as well.

So, I misspoke about 9x vs 3x position size to match the risk, but the point still stands... The gamma risk is proportional to theta and this is the sense in which theta is valuable as a risk measure.

 

[sle]

theta is not a risk metric on it's own.

Disagree there. I think theta is a primary risk indicator/metric for a book. If you are collecting, you are somehow short risk premium, while any other metric could be misleading for a complex book.

 

[JackRab]

@monkeyjoe no sorry.. you're right. my bad.

 

[JackRab]

Disagree there. I think theta is a primary risk indicator/metric for a book. If you are collecting, you are somehow short risk premium, while any other metric could be misleading for a complex book.

In my view just theta doesn't mean that much... because the risk depends on where you hold the position. You can have a very low theta, but still high risk... if the stock has moved away for instance.
Also, you can easily construct a zero-theta or even positive theta with positive gamma position... Which sounds great, but it has risks...

It's just too dynamic...

 

[destriero]

That's a BS number... theta is not a risk metric on it's own. If he means he's comfortable to just make 1% of netliq on theta... okay... but where's the theta coming from? 3 DTE? 30 DTE? That's the big question you should be looking at.
A 1% theta of netliq 30 days out is way more risky than 3 days out....

You need about 3x the position 30 days out to get the same portfolio theta as 3 DTE

DTE is meaningless. The 1% figure refers to your global book, not one position. It is absolutely a risk-measure -- specifically your (dollar) local risk on short gamma. It's utility relates to it being dollar-risk.

And the "1%" is commonplace on bank/prop/buy-side desks in the industry. The first time I heard the "1%" mentioned was from a guy whom made like $35MM last year.

 

[destriero]

In my view just theta doesn't mean that much... because the risk depends on where you hold the position. You can have a very low theta, but still high risk... if the stock has moved away for instance.
Also, you can easily construct a zero-theta or even positive theta with positive gamma position... Which sounds great, but it has risks...

It's just too dynamic...

Let's see a MTM position that is +gamma +theta.

 

[JackRab]

DTE is meaningless. The 1% figure refers to your global book, not one position. It is absolutely a risk-measure -- specifically your (dollar) local risk on short gamma.

And the "1%" is commonplace on bank/prop/buy-side desks in the industry. The first time I heard the "1%" mentioned was from a guy whom made like $35MM last year.

If you don't know where that 1% is coming from you're a sitting duck...

That's why a lot of option retail traders have no clue... because they just look at that '1%' and think they're brilliant for having found an options cash machine...
But they don't know gamma or vega and how all the relations between options work.

But if you just want to stare at that theta number with $$-signs in your eyes... good luck.

That guy you mentioned... is he a banker? I know prop traders at banks that ran big books and just before they would go on a holiday, they would sell OTM puts non hedged...
Just because they could and hey... it's the banks money anyway so who cares?

Great strategy that is...

And then Jerome Kerviel drops in and you lose 3 bln....

 

[destriero]

If you don't know where that 1% is coming from you're a sitting duck...

That's why a lot of option retail traders have no clue... because they just look at that '1%' and think they're brilliant for having found an options cash machine...
But they don't know gamma or vega and how all the relations between options work.

But if you just want to stare at that theta number with $$-signs in your eyes... good luck.

That guy you mentioned... is he a banker? I know prop traders at banks that ran big books and just before they would go on a holiday, they would sell OTM puts non hedged...
Just because they could and hey... it's the banks money anyway so who cares?

Great strategy that is...

And then Jerome Kerviel drops in and you lose 3 bln....

Dude, no offense, but you are embarrassing yourself.

 

[JackRab]

Let's see a MTM position that is +gamma +theta.

short risk reversal, short OTM puts which have a higher theta and lower gamma than the long position in OTM calls, in the case of high skewness (which is pretty normal)

short front month strangle on fairly high IV and long further dated straddle on lower IV...