Art and Science
Although this was a very simplified example, it was typical of how a
profitable week of gamma scalping plays out. This stock had a pretty
volatile week, and overall the week was a winner: there were four losing
days and three winners. The number of losing days includes the weekends.
Weekends and holidays are big hurdles for long-gamma traders because of
the theta loss. The biggest contribution to this being a winning week was
made by the gap open on day four. Part of the reason was the sheer
magnitude of the move, and part was the fact that the deltas weren’t covered
too soon, as they had been on day three.
In a perfect world, a long-gamma trader will always buy the low of the
day and sell the high of the day when covering deltas. This, unfortunately,
seldom happens. Long-gamma traders are very often wrong when trading
stock to cover deltas.
Being wrong can be okay on occasion. In fact, it can even be rewarding.
Day three was profitable despite the fact that 140 shares were sold at
$40.50, $41, and $41.50. The stock closed at $42; the first three stock trades
were losers. Harry sold stock at a lower price than the close. But the
position still made money because of his positive gamma. To be sure, Harry
would like to have sold all 560 shares at $42 at the end of the day. The day’s
profits would have been significantly higher.
The problem is that no one knows where the stock will move next. On
day three, if the stock had topped out at $40.50 and Harry did not sell stock
because he thought it would continue higher, he would have missed an
opportunity. Gamma scalping is not an exact science. The art is to pick
spots that capture the biggest moves possible without missing opportunities.
There are many methods traders have used to decide where to cover
deltas when gamma scalping: the daily standard deviation, a fixed
percentage of the stock price, a fixed nominal value, covering at a certain
time of day, “market feel.” No system appears to be absolutely better than
another. This is where it gets personal. Finding what works for you, and
what works for the individual stocks you trade, is the art of this science.