Day Four
Day four offered a rather unpleasant surprise. This was the day that the
stock gapped open $4 lower. This is the kind of day short-gamma traders
dread. There is, of course, no right way to react to this situation. The stock
can recover, heading higher; it can continue lower; or it can have a dead-cat
bounce, remaining where it is after the fall.
Staring at a quite contrary delta of 11.20, Mary was forced to take action
by selling stock. But how much stock was the responsible amount to sell for
a pure short-gamma trader not interested in trading direction? Selling 1,120
shares would bring the position back to being delta neutral, but the only
way the trade would stay delta neutral would be if the stock stayed right
where it was.
Hedging is always a difficult call for short-gamma traders. Long-gamma
traders are taking a profit on deltas with every stock trade that covers their
deltas. Short-gamma traders are always taking a loss on delta. In this case,
Mary decided to cover half her deltas by selling 560 shares. The other 560
deltas represent a loss, too; it’s just not locked in.
Here, Mary made the conscious decision not to go home flat. On the one
hand, she was accepting the risk of the stock continuing its decline. On the
other hand, if she had covered the whole delta, she would have been
accepting the risk of the stock moving in either direction. Mary felt the
stock would regain some of its losses. She decided to lead the stock a little,
going into the weekend with a positive delta bias.