Greeks and Income Generation
With volatility-selling strategies (sometimes called income-generating
strategies), greeks are often overlooked. Traders simply dismiss greeks as
unimportant to this kind of trade. There is some logic behind this reasoning.
Time decay provides the profit opportunity. In order to let all of time
premium erode, the position must be held until expiration. Interim changes
in implied volatility are irrelevant if the position is held to term. The
gamma-theta loses some significance if the position is held until expiration,
too. The position has either passed the break-even point on the at-expiration
diagram, or it has not. Incremental daily time decay–related gains are not
the ultimate goal. The trader is looking for all the time premium, not
portions of it.
So why do greeks matter to volatility sellers? Greeks allow traders to be
flexible. Consider short-term-momentum stock traders. The traders buy a
stock because they believe it will rise over the next month. After one week,
if unexpected bearish news is announced causing the stock to break through
its support lines, the traders have a decision to make. Short-term speculative
traders very often choose to cut their losses and exit the position early rather
than risk a larger loss hoping for a recovery.
Volatility-selling option traders are often faced with the same dilemma. If
the underlying stays in line with the traders’ forecast, there is little to worry
about. But if the environment changes, the traders have to react. Knowing
the greeks for a position can help traders make better decisions if they plan
to close the position before expiration.