Day One
This was one of the volatile days. The stock rallied from $40 to $42 early in
the day and had fallen back down to $40 by the end of the day. Big moves
like this are hard to trade as a short-gamma trader. As the stock rose to $42,
the negative delta would have been increasing. That means losses were
adding up at an increasing rate. The only way to have stopped the
hemorrhaging of money as the stock continued to rise would have been to
buy stock. Of course, if Mary buys stock and the stock then declines, she
has a loser.
Let’s assume the best-case scenario. When the stock reached $42 and she
had a −560 delta, Mary correctly felt the market was overbought and would
retrace. Sometimes, the best trades are the ones you don’t make. On this
day, Mary traded no stock. When the stock reached $40 a share at the end of
the day, she was back to being delta neutral. Theta makes her a winner
today.
Because of the way Mary handled her trade, the volatility of day one was
not necessarily an impediment to it being profitable. Again, the assumption
is that Mary made the right call not to negative scalp the stock. Mary could
have decided to hedge her negative gamma when the stock reach $42 and
the position delta was at −$560 by buying stock and then selling it at $40.
There are a number of techniques for hedging deltas resulting from
negative gamma. The objective of hedging deltas is to avoid losses from the
stock trending in one direction and creating increasingly adverse deltas but
not to overtrade stock and negative scalp.