Excellent post.
However, on this point, I do the opposite: I usually seek out illiquid options and only trade against MM.
Long gamma vs long the underlying
- Thread starter sss12
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However, on this point, I do the opposite: I usually seek out illiquid options and only trade against MM.
Yes, you are absolutely right. I assume stable vol since modeling/predicting it is above my pay grade. I am aware of the change in vol and its impact, but if I get the direction of the delta right I usually have a profitable outcome, Maybe not as much if vega was working against me.
Yes, I am usually one week or less to expiry. This is a very st strategy 1-3 days. As I said still a work in progress...thanks for the input.
@TrustyJules ...one additional comment.
What I do when calculating my potential appreciation is just use delta and not any benefits from gamma. This way if I do get the direction right the gamma will offset vega (if going in wrong direction)...if vol is helping me , great.
Again, thanks for the comments. It confirms my suspicions on the strategy...there can be positive expectancy but not a lock by any means.
What my goal is is to get my system to a sustainable win-loss ratio on the direction of delta that can be used to trade the underlying as well as options..not there yet.
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Well you raise an interesting issue as to whether there is a rule of thumb kind of thing that could help you further filter your directional bets, i.e. where you have worse expectancy of gamma overcoming theta. In my original response I started working out a possible method that takes in the various dynamic parameters but there are too many of them for a quick answer. The immediate considerations are these
Here is your first issue - as you get closer to expiration your gamma will increase hence even if we look at just the final week before expiration we have an issue that the ground moves under your feet.
Second consideration:
Low volatility stocks have lower gamma than high volatility stocks. Furthermore the price of the underlying also impacts this equation. That is self evident when you consider that a 1pt move for a 10$ stock is quite something else to a 1$ move for a 1000$ stock like Google. A low volatility stock has low option prices and therefore lower theta but the low volatility also affects to lower gamma.
The preliminary conclusions from the above would be that as you want your ratio to be attractive the lower the more the theta/gamma is your gamma cost for the day. More volatile and closer to expiration the more gamma will be strong and hence capable of overcoming theta. I cant draw a conclusion as to a level at which one should have a trigger but lets arbitrarily set that 1 - so dont go into a trade (or exit it if already in) the moment theta becomes larger than gamma.
When you say volatility is above your pay grade this is kind of funny. Gamma and vega are the two ways to trade volatility. Therefore not only should you be aware of volatility you are in fact already taking it into account in what you do. The gamma rent concept is used by professional traders when doing arbitrages for example.
Once thing you can do is to plot for a specific underlying the cost to hold one gamma depending on volatility. You can then search for to buy the cheap volatility and sell the expensive one and find at what level of volatility you break even. In the spread you
long theta-short theta
====================
long gamma-short gamma
That gives you a number you can look up on your table and will tell you where you need volatility to be for your spread to stay above water. The same logic applies to buying calls which you delta neutralise by shorting stock, when you do this you are in fact cashing in on realised vega through owning gamma. If IV was higher when you liquidated the delta neutral position than when you bought it you would make money and conversely you would lose money if it were lower than when you bought it. There is great reddit post with the above in better words than mine here
I am not sure if the above helps you with your directional trades - my conclusion simply was that the move you are trying to predict through the simple method of a w/l ratio has many variables that make the w/l perse not be enough for an accurate prediction. Nevertheless if you can predict your 1pt moves then the theta/gamma ratio could be an indicator for you to enter or not to enter a trade.
Here is your first issue - as you get closer to expiration your gamma will increase hence even if we look at just the final week before expiration we have an issue that the ground moves under your feet.
Second consideration:
Low volatility stocks have lower gamma than high volatility stocks. Furthermore the price of the underlying also impacts this equation. That is self evident when you consider that a 1pt move for a 10$ stock is quite something else to a 1$ move for a 1000$ stock like Google. A low volatility stock has low option prices and therefore lower theta but the low volatility also affects to lower gamma.
The preliminary conclusions from the above would be that as you want your ratio to be attractive the lower the more the theta/gamma is your gamma cost for the day. More volatile and closer to expiration the more gamma will be strong and hence capable of overcoming theta. I cant draw a conclusion as to a level at which one should have a trigger but lets arbitrarily set that 1 - so dont go into a trade (or exit it if already in) the moment theta becomes larger than gamma.
When you say volatility is above your pay grade this is kind of funny. Gamma and vega are the two ways to trade volatility. Therefore not only should you be aware of volatility you are in fact already taking it into account in what you do. The gamma rent concept is used by professional traders when doing arbitrages for example.
Once thing you can do is to plot for a specific underlying the cost to hold one gamma depending on volatility. You can then search for to buy the cheap volatility and sell the expensive one and find at what level of volatility you break even. In the spread you
long theta-short theta
====================
long gamma-short gamma
That gives you a number you can look up on your table and will tell you where you need volatility to be for your spread to stay above water. The same logic applies to buying calls which you delta neutralise by shorting stock, when you do this you are in fact cashing in on realised vega through owning gamma. If IV was higher when you liquidated the delta neutral position than when you bought it you would make money and conversely you would lose money if it were lower than when you bought it. There is great reddit post with the above in better words than mine here
I am not sure if the above helps you with your directional trades - my conclusion simply was that the move you are trying to predict through the simple method of a w/l ratio has many variables that make the w/l perse not be enough for an accurate prediction. Nevertheless if you can predict your 1pt moves then the theta/gamma ratio could be an indicator for you to enter or not to enter a trade.
That's good stuff...thanks.Well you raise an interesting issue as to whether there is a rule of thumb kind of thing that could help you further filter your directional bets, i.e. where you have worse expectancy of gamma overcoming theta. In my original response I started working out a possible method that takes in the various dynamic parameters but there are too many of them for a quick answer. The immediate considerations are these
Here is your first issue - as you get closer to expiration your gamma will increase hence even if we look at just the final week before expiration we have an issue that the ground moves under your feet.
Second consideration:
Low volatility stocks have lower gamma than high volatility stocks. Furthermore the price of the underlying also impacts this equation. That is self evident when you consider that a 1pt move for a 10$ stock is quite something else to a 1$ move for a 1000$ stock like Google. A low volatility stock has low option prices and therefore lower theta but the low volatility also affects to lower gamma.
The preliminary conclusions from the above would be that as you want your ratio to be attractive the lower the more the theta/gamma is your gamma cost for the day. More volatile and closer to expiration the more gamma will be strong and hence capable of overcoming theta. I cant draw a conclusion as to a level at which one should have a trigger but lets arbitrarily set that 1 - so dont go into a trade (or exit it if already in) the moment theta becomes larger than gamma.
When you say volatility is above your pay grade this is kind of funny. Gamma and vega are the two ways to trade volatility. Therefore not only should you be aware of volatility you are in fact already taking it into account in what you do. The gamma rent concept is used by professional traders when doing arbitrages for example.
Once thing you can do is to plot for a specific underlying the cost to hold one gamma depending on volatility. You can then search for to buy the cheap volatility and sell the expensive one and find at what level of volatility you break even. In the spread you
long theta-short theta
====================
long gamma-short gamma
That gives you a number you can look up on your table and will tell you where you need volatility to be for your spread to stay above water. The same logic applies to buying calls which you delta neutralise by shorting stock, when you do this you are in fact cashing in on realised vega through owning gamma. If IV was higher when you liquidated the delta neutral position than when you bought it you would make money and conversely you would lose money if it were lower than when you bought it. There is great reddit post with the above in better words than mine here
I am not sure if the above helps you with your directional trades - my conclusion simply was that the move you are trying to predict through the simple method of a w/l ratio has many variables that make the w/l perse not be enough for an accurate prediction. Nevertheless if you can predict your 1pt moves then the theta/gamma ratio could be an indicator for you to enter or not to enter a trade.