39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
892 Part VI: Measuring and Trading Volatility
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respect to more than one risk variable requires one to approach the problem as he
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did when the position was established: Neutralize the gamma first, and then use stock
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to adjust the delta. Note the difference between this approach and the one described
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in the previous paragraph. Here, we are trying to adjust gamma first, and will get to
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delta later.
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In order to add some positive gamma, one might want to buy back (cover) some
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of the January 70 calls that are currently short. Suppose that the decision is made to
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cover when XYZ reaches 65.50 in 14 days. From the graph above, one can see that
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the position would be approximately gamma short 700 shares at the time. Suppose
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that the gamma of the January 70 calls is 0.07. Then, one would have to cover 100
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January 70 calls to add 700 shares of positive gamma to the position, returning it to
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gamma neutral. This purchase would, of course, make the position delta long, so
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some stock would have to be sold short as well in order to make the position delta
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neutral once again.
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Thus, the procedure for follow-up action is somewhat similar to that for estab
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lishing the position: First, neutralize the gamma and then eliminate the resulting
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delta by using the common stock. The resulting profit graph will not be shown for
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this follow-up adjustment, since the process could go on and on. However, a few
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observations are pertinent. First, the purchase of calls to reduce the negative gamma
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hurts the original thesis of the position - to have negative vega and positive theta, if
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possible. Buying calls will add vega to and subtract theta from the position, which is
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not desirable. However, it is more desirable than letting losses build up in the posi
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tion as the stock continues to run to the upside. Second, one might choose to rerrwve
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the position if it is profitable. This might happen if the volatility did decrease as
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expected. Then, when the stock rallies, producing negative gamma, one might actu
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ally have a profit, because his assumption concerning volatility had been right. If he
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does not see much further potential gains from decreasing volatility, he might use the
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point at which negative gamma starts to build up as the exit point from his position.
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Third, one might choose to accept the acquired gamma risk. Rather than jeopardize
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his initial thesis, one may just want to adjust the delta and let the gamma build up.
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This is no longer a neutral strategy, but one may have reasons for approaching the
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position this way. At least he has calculated the risk and is aware of it. If he chooses
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to accept it rather than eliminate it, that is his decision.
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Finally, it is obvious that the process is dynamic. As factors change (stock price,
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volatility, time), the position itself changes and the strategist is presented with new
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choices. There is no absolutely correct adjustment. The process is more of an art than
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a science at times. Moreover, the strategist should continue to recalculate these prof
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it pictures and risk measures as the stock moves and time passes, or if there is a |