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Is it possible to backtest an gamma scalping strategy?
- Thread starter Rudolf13100
- Start date
Ok.
So, I am asking myself the following:
1- Generally do we use options that have 1 month less to expiration, 3 months, 6 months... do we use a ratio IV/theta to determine which options to choose in the option chain?
2- Is the maximum potential loss equal to the amount of time decay in the options?
3- can we say that the purchase of a simple strandle is a bet on higher volatility and/or great move in the underlying whereas gamma scalping is more uniquely a bet on higher volatility?
So, I am asking myself the following:
1- Generally do we use options that have 1 month less to expiration, 3 months, 6 months... do we use a ratio IV/theta to determine which options to choose in the option chain?
2- Is the maximum potential loss equal to the amount of time decay in the options?
3- can we say that the purchase of a simple strandle is a bet on higher volatility and/or great move in the underlying whereas gamma scalping is more uniquely a bet on higher volatility?
1. all depends on your taste, you can use whatever option you want, although longer term options will probably mean you are going to allocate a lot of capital to that for quite a while. Reasons to take longer term options is that their implied vol might differ substantially from the implied vol of short term options, another reason might be that the impact of a change in vol will be bigger on longer dated options. (if implied vol goes up as realised vol tends to be higher, you can just take the profit in the options to, no need to hold it till expiration)
2 theoretically yes, in practice however no, as soon as you start to scalp you are going to recoup some of your losses due to theta. So as long as the stock moves, you will make some money back.
3 it kind of the same thing, in fact the initial action is the same, it's the way you play it that differs: most retail investors that buy straddles don't hedge, so they want either higher implied vol or a good one directional move (well in most cases the latter). If you deltahedge (gamma-scalp) however it's the realised volatility that counts, but if implied goes higher till the level you expect realised to get, you just take the profit in the options and stop the hedging.
2 theoretically yes, in practice however no, as soon as you start to scalp you are going to recoup some of your losses due to theta. So as long as the stock moves, you will make some money back.
3 it kind of the same thing, in fact the initial action is the same, it's the way you play it that differs: most retail investors that buy straddles don't hedge, so they want either higher implied vol or a good one directional move (well in most cases the latter). If you deltahedge (gamma-scalp) however it's the realised volatility that counts, but if implied goes higher till the level you expect realised to get, you just take the profit in the options and stop the hedging.
Rudolf, I think you're trying to see gamma scalping as a complete, soup-to-nuts option trading strategy. It's not. It's just a piece of the puzzle, an arrow in the quiver, a tool in the toolbox - to be taken out and used when appropriate.
If you took a class on the proper use of a hammer in carpentry, that doesn't mean you're supposed to build a house with a hammer alone. It means that when you run into a situation where a hammer is appropriate, you'll understand how best to use it.
Option trading is a fluid, multi-dimensional process with infinite possibilities. The more "tools" you understand and have at your disposal, the better an options "craftsman" you will be.
It's impossible to enumerate all the situations where you might want to scalp your gammas. The article was inspired by a situation in May 2007 where T-bond option premium had fallen to the lowest levels I had ever seen - and I've been watching it for 25 years. At that moment, there was absolute agreement everywhere that the economy was perfect, nothing could go wrong, and rates could not rise. It was one of those amazingly juicy situations that come along rarely, so I bought gobs of back-month premium. While waiting for the mood to change and for T-bonds to plunge (I didn't have to wait long, as it turned out), I scalped my gammas to offset time decay. I was long gammas of course, so once T-bonds did start to fall I got shorter and shorter deltas, and at times I would buy T-bonds to lock in profits - another use of scalping gammas.
Perhaps the best way to sum up the whole gamma scalping subject is to simply understand that whenever you're long gammas and even up your deltas (become delta neutral again), you're locking in a profit. When you're short gammas and even up your deltas, you're locking in a loss. That's the crux of it. Once you feel you've gotten your mind around that concept, you can stick gamma scalping in the old toolbox and move on to understanding the next tool.
If you took a class on the proper use of a hammer in carpentry, that doesn't mean you're supposed to build a house with a hammer alone. It means that when you run into a situation where a hammer is appropriate, you'll understand how best to use it.
Option trading is a fluid, multi-dimensional process with infinite possibilities. The more "tools" you understand and have at your disposal, the better an options "craftsman" you will be.
It's impossible to enumerate all the situations where you might want to scalp your gammas. The article was inspired by a situation in May 2007 where T-bond option premium had fallen to the lowest levels I had ever seen - and I've been watching it for 25 years. At that moment, there was absolute agreement everywhere that the economy was perfect, nothing could go wrong, and rates could not rise. It was one of those amazingly juicy situations that come along rarely, so I bought gobs of back-month premium. While waiting for the mood to change and for T-bonds to plunge (I didn't have to wait long, as it turned out), I scalped my gammas to offset time decay. I was long gammas of course, so once T-bonds did start to fall I got shorter and shorter deltas, and at times I would buy T-bonds to lock in profits - another use of scalping gammas.
Perhaps the best way to sum up the whole gamma scalping subject is to simply understand that whenever you're long gammas and even up your deltas (become delta neutral again), you're locking in a profit. When you're short gammas and even up your deltas, you're locking in a loss. That's the crux of it. Once you feel you've gotten your mind around that concept, you can stick gamma scalping in the old toolbox and move on to understanding the next tool.
Quote from Rudolf13100:
1- Generally do we use options that have 1 month less to expiration, 3 months, 6 months... do we use a ratio IV/theta to determine which options to choose in the option chain?
Time frame is irrelevant (unless its based on user defined outlook of future volty) : greeks trade ofs.
Same goes for strike selections ( otm=itm=atm)
Quote from IV_Trader:
OP , you are almost guaranteed to lose money if you scalp ( long) based on some comments on this thread.
Good luck to you
I mostly agree with this - not that anyone has been giving bad advice in this thread, just that I think the OP has the same misconception about option trading that I see so often (universally actually) among options newcomers - namely, that there is a "best strategy" for trading options, and that success is just a matter of finding that "best strategy" and learning how to use it.
Of course, that's not it IMHO. The only way I know to get an edge as a retail trader is to become very familiar with normal pricing relationships and patterns, and volatility relationships and patterns, so you will notice when any of these get out of line. When they do, you will need excellent knowledge of greeks and options to take advantage of them. At some point in the course of doing that, you may find yourself long premium with the market whipping around. When that happens, you'll want to understand gamma scalping so you can take advantage of that movement.
That's the context in which I would understand gamma scalping - not as a standalone strategy.
In any case, the choice of strategy should be dictated by prevailing market conditions at that moment. You don't just blindly impose a strategy on the market because it's supposedly a good one. A strategy that's appropriate today may make absolutely no sense tomorrow. It's like sailing - there's no "best" point of sail - the proper choice depends on where you want to go and which way the wind is blowing.
Quote from IV_Trader:
OP , you are almost guaranteed to lose money if you scalp ( long) based on some comments on this thread.
Good luck to you
Please be a little more specific so I can learn. Also, don't hesitate posting any links if you have interesting materials for me to read. I find it hard to find anything interesting on the subject.
What does "OP" means?
Thanks to all of you for all your replies.
Quote from dmo:
I mostly agree with this - not that anyone has been giving bad advice in this thread, just that I think the OP has the same misconception about option trading that I see so often (universally actually) among options newcomers - namely, that there is a "best strategy" for trading options, and that success is just a matter of finding that "best strategy" and learning how to use it.
Of course, that's not it IMHO. The only way I know to get an edge as a retail trader is to become very familiar with normal pricing relationships and patterns, and volatility relationships and patterns, so you will notice when any of these get out of line. When they do, you will need excellent knowledge of greeks and options to take advantage of them. At some point in the course of doing that, you may find yourself long premium with the market whipping around. When that happens, you'll want to understand gamma scalping so you can take advantage of that movement.
That's the context in which I would understand gamma scalping - not as a standalone strategy.
In any case, the choice of strategy should be dictated by prevailing market conditions at that moment. You don't just blindly impose a strategy on the market because it's supposedly a good one. A strategy that's appropriate today may make absolutely no sense tomorrow. It's like sailing - there's no "best" point of sail - the proper choice depends on where you want to go and which way the wind is blowing.
I have recently started to read about options and heard about the concept of volatility trading. My goal is to become familiar with techniques of volatility trading. I have read a few books and they all seem to repeat the same information. Sometimes in web searches I come across terms such as "gamma-scalping" or "dispersion trading" and I wanted to know what it was (i had not seen those terms in option books).
I know that at this point I don't have the knowledge to successfullly trade options. Still, I wish to learn. For instance, I would love to learn about "the normal pricing relationships and patterns, and volatility relationships and patterns"and being able to "notice when they are out of line", but how do I do that? The McMillan, natengerg... books always mentioned don't teach you that. Please tell me how to learn.