Preferred Structures for Gamma Scalping

stevenpaul · Nov 19, 2010

Hello folks,

That gamma scalping is no panacea has been made abundantly clear by the numerous threads on the topic in this forum. By the same token, I've traded enough long straddles to appreciate the potential merit of gamma scalping, having witnessed profit mount today, dissipate tomorrow, accumulate again Thursday morning, dematerialize by the close, etc. Assuming for a moment that the philosophy of gamma scalping is valid and worthwhile, what is your preferred strategy for taking advantage of long gamma, with the intention of scalping? The straddle is the main strategy used by scalpers, it seems, but is it the best? Are there alternatives that afford a better ratio of gamma to theta? Take a short calendar spread, for example: + 1 PFE DEC10 17 Call, - 1 PFE JUN 11 17 Call. Net Gamma is 28.3 and net theta is -.36. Gamma/theta is -77. A straddle of PFE DEC10 17 has a gamma of 85.67 and theta of - 1.25. Gamma/theta = -68, which, while a good price for the gamma, is still higher than in the short calendar. Putting vega aside momentarily, wouldn't the calendar actually be a better deal, if the goal were to play the long gamma? Moreover, short calendars generally do seem to offer more gamma for the money than straddles, in my observation. Short calendars are just one example of an alternative. There are obviously numerous structures that yield positive gamma while starting off delta neutral: short butterlies and condors, backspreads, wrangles, various diagonals and double diagonals, short calendar straddles and strangles, and so on. I imagine there are even more structures than those. It gets a little daunting trying to sort through them and figure out which would lend itself to gamma scalping the best. Vega must be taken into consideration, of course, and ideally we could find two optimal structures that could each be used for gamma scalping, one long vega, the other short vega. Thus, we could choose the strategy corresponding to our outlook for the underlier's future IV.

Thank you very much for your consideration of this question! I have learned a great deal by taking these sorts of polls here on ET. Hopefully the topic will prove edifying for other readers as well!

spindr0 · Nov 19, 2010

The success of your option strategy depends on selecting the right one for the UL's subsequent behavior.

For gamma scalping, if you're wrong on IV, the scalp will soften the double sided contract premium loss. If you scalp early, the equity leg will become a drag on a more protracted move, reducing gains (opportunity loss). If you aim to scalp at a certain delta but the UL doesn't get there, you miss that move and one side's profit dissipates (opportunity loss). There are problems with everything you can do. There's no panacea

IMO, the success of gamma scalping is being on the right side of IV and good guessing in the timing your stock adjustments. Anyone who can do that consistently shouldn't be gamma scalping.

stevenpaul · Nov 20, 2010

Quote from spindr0:

The success of your option strategy depends on selecting the right one for the UL's subsequent behavior.

Insightful post, spindr0. I'm in complete agreement that IV outlook must be factored into the choice of strategies. I was actually saying as much in my own, perhaps excessively lengthy original post. What I was hoping to get going here is a small chat about which strategies could be turned to for scalping gammas in various IV outlooks. As I was alluding to above, a short calendar could perhaps be used to scalp gammas when declining IV is expected, and of course straddles could be used when an increase in IV is anticipated. I'm not advocating those two strategies, per se, but that is one example of a complete long gamma repertoire, one comprised of strategies that could be turned to for either type of IV outlook. I suppose if the outlook were neutral one could use either long or short vega strategies. What other complete long gamma repertoires could we come up with, and how would they compare to the one I mentioned?

Thanks again.

spindr0 · Nov 21, 2010

Quote from stevenpaul:

What I was hoping to get going here is a small chat about which strategies could be turned to for scalping gammas in various IV outlooks. As I was alluding to above, a short calendar could perhaps be used to scalp gammas when declining IV is expected, and of course straddles could be used when an increase in IV is anticipated.

I'm a bit confused. Are you trying to identify strategies that capitalize on change in IV or are you trying to utilize the underlying to scalp the delta imbalance that occurs when the components of your position get some distance from neutral?

stevenpaul · Nov 22, 2010

Quote from spindr0:

I'm a bit confused. Are you trying to identify strategies that capitalize on change in IV or are you trying to utilize the underlying to scalp the delta imbalance that occurs when the components of your position get some distance from neutral?

Both, Spindr0. I prefer the types of trades that offer multiple ways to profit. With straddles and short calendars, we can profit off of both changes in IV and delta creation. That is rather appealing, but I'm not certain that those two structures are the best of their kind. Are there better strategies for being long gamma with short vega, and long gamma with long vega, respectively? If we had a repertoire of strategies that could each be used for gamma scalping, but some of which were long vega, others short vega, then we would be armed for gamma scalping in any type of IV environment.