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How to trade Gamma Scalping

Dharam Chand Sethia Blog 5 Comments

Gamma scalping is the process of adjusting the deltas of a long option premium and long gamma portfolio of options in an attempt to scalp enough money to offset the time decay of the position.

Purpose

When we buy options, our biggest fear is time decay; not the direction of underlying (for that we have stop losses). Gamma scalping involves buying and selling of the underlying at defined intervals (measured by delta).

Before I proceed further, let me define —

Long CallLong Put
DeltaPositiveNegative
GammaPositivePositive
VegaPositivePositive
ThetaNegativeNegative
Further Delta of Underlying/Futures is 1.

 

Thought Process

  1. Find an underlying where you think volatility is going to be higher, reason could be (earnings, budget, events, elections)
  2. A low volatility (low IVP) stock is a good choice to initiate a trade in this - Not necessarily. It should have any visibility of an event happening, or else it will become a Hope Trade.
  3. Frequency of scalping is 2nd key determinant of success in this trade - using major support & resistance as mean reversion points may enhance your returns.
  4. Exit should be made before the event occurs.
  5. Also look for developments in stocks delivery, Open Interest.

A picture speaks a thousand words

Image

 

The purple bars in the graph are Implied Volatility of Infosys. It rose prior to its result date, kept rising and fell after results announcement. In between July & October there is another rise in volatility which was due to exit of Dr Vishal Sikka. We can only plan for the known events & trade them.

Risk

  1. Fall in volatility before the event.
  2. Staying through the event & stock does not move.
  3. Too little movement in stock prior to the event resulting in low scalping opportunity.
  4. Short selling the stock is not possible on end of the day basis.

XYZ is going to announce its results 15th of the month. Volatility at the last time of result was 40%, currently it is quoting at 32% (Date- 1st of the month). From 1st to 15th there is going to be a rise in volatility ( or the straddle value will remain same). Buy a ATM straddle on 1st and wait for the XYZ to move. Our objective is to remain DELTA-NEUTRAL at all times.

ATM straddle is a delta neutral position.

As soon as XYZ moves away from ATM the delta will also change.

If XYZ goes down, put delta increases & call Delta Decreases, resulting in net negative delta. This negative delta will be neutral by buying XYZ stock equal to delta (remember stock delta =1). If XYZ goes up, the net delta will be positive and will become neutral by selling XYZ stock.

Image

Since maximum delta of call is +1 & put is -1 , for the above position the number of shares bought/sold cannot exceed number of option(in shares) bought. That means; at extremes, if I have 1000 straddle long I will either have 1000 shares long (in case XYZ goes down) or 1000 shares short(in case XYZ goes up) – a hedged position.

The more XYZ oscillates in a range the more opportunity we get to scalp our trade.

Happy Trading!

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Comments 5

  1. sir as u said cash cant b sold and kept in position eod. will u plz explain it with excel with refernce to future lot plz, again entry and exit how to decide.

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      Author

      Let’s say you need to sell in cash market 200 shares of reliance to go delta neutral.In this case one can buy in cash market 300 shares and sell futures 1 lot(500 shares).Though it increases the cost of transaction but it will give you perfect delta neutral position.Generally this process is avoided due to high transaction cost in cash markets as it eats into your yields.

  2. Hello Sir,

    Nice explanation. I will like to know how can I get Implied Volatility data as you have shown in the figure above.

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      Author

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