EXHIBIT 15.2 Long straddle P&(L) at initiation and expiration.
Because this is a short-term at-the-money (ATM) straddle, we will
assume for simplicity that it has a delta of zero. 1 When the trade is
consummated, movement can only help, as indicated by the dotted line on
the exhibit. This is the classic graphic representation of positive gamma—
the smiley face. When the stock moves higher, the call gains value at an
increasing rate while the put loses value at a decreasing rate. When the
stock moves lower, the put gains at an increasing rate while the call loses at
a decreasing rate. This is positive gamma.
This still may not be an entirely fair representation of how profits are
earned. The underlying is not required to move continuously in one
direction for traders to reap gamma profits. As described in Chapter 13,
traders can scalp gamma by buying and selling stock to offset long or short
deltas created by movement in the underlying. When traders scalp gamma,
they lock in profits as the stock price oscillates.
The potential for gamma scalping is an important motivation for straddle
buyers. Gamma scalping a straddle gives traders the chance to profit from a
stock that has dynamic price swings. It should be second nature to volatility
traders to understand that theta is the trade-off of gamma scalping.