27 lines
1.8 KiB
Plaintext
27 lines
1.8 KiB
Plaintext
Gamma Hedging
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Knowing that the gamma and theta figures of Exhibit 13.1 are derived from
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a 25 percent volatility assumption offers a benchmark with which to gauge
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the potential profitability of gamma trading the options. If the stock’s
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standard deviation is below 25 percent, it will be difficult to make money
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being long gamma. If it is above 25 percent, the play becomes easier to
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trade. There is more scalping opportunity, there are more opportunities for
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big moves, and there are more likely to be gaps in either direction. The 25
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percent volatility input not only determines the option’s theoretical value
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but also helps determine the ratio of gamma to theta.
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A 25 percent or higher realized volatility in this case does not guarantee
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the trade’s success or failure, however. Much of the success of the trade has
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to do with how well the trader scalps stock. Covering deltas too soon leads
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to reduced profitability. Covering too late can lead to missed opportunities.
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Trading stock well is also important to gamma sellers with the opposite
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trade: sell calls and buy stock delta neutral. In this example, a trader will
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sell 20 ATM calls and buy stock on a delta-neutral ratio.
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This is a bearish position in realized volatility. It is the opposite of the
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trade in the last example. Consider again that 25 percent IV is the
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benchmark by which to gauge potential profitability. Here, if the stock’s
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volatility is below 25, the chances of having a profitable trade are increased.
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Above 25 is a bit more challenging.
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In this simplified example, a different trader, Mary, plays the role of
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gamma seller. Over the same seven-day period as before, instead of buying
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calls, Mary sold a 20 lot. Exhibit 13.2 shows the analytics for the trade. For
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the purposes of this example, we assume that gamma remains constant and
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the trader is content trading odd lots of stock. |