I received the following question regarding last week's RIMM and Gamma Scalping post. Great post Tyler! Gamma scalping is one of those subjects that gives me a glimpse into the mind of a "real" trader. You are a much better directional trader than I am, so I am wondering: is this a strategy you do regularly? How much of your account would you put into a scalping straddle? Do you re-adjust the position when it moves a certain percentage or delta, or do you rely on support/resistance on shorter time frame charts?
Jon
Thanks for the question Jon. Perhaps you give me too much credit on being "a much better directional trader" than you. Nonetheless I appreciate the kind words. Gamma scalping is not really a strategy I do that often. Though in theory it seems like a slam dunk, when the rubber meets the road there's a lot of moving parts that have to come together to make it work well. Since much of 2009 and 2010 has experienced a declining volatility environment, I haven't seen much of an edge in being a net buyer of options. The occasional corrections have obviously reward option buyers, but those have been few and far between. Remember, the ideal market environment for straddles (and gamma scalping) is one in which the realized volatility of the underlying is significantly higher than the implied vol paid for in the option's at trade inception. The reason I gave the straddle a shot on RIMM was because its volatility seemed at a cyclical low making option's a more tempting purchase.
As far as position sizing goes it really comes down to personal preference. I'm not sure I'd treat a long straddle much different than any other individual options play regardless of if I'm gamma scalping or not. So if you typically risk 2% of your account in each individual trade, I'd keep it similar with the straddle. Though you're not taking on a lot of directional risk when entering a straddle, you are fighting time decay the entire time which can start to add up if the underlying doesn't move sufficiently.
Timing has always been the toughest part of gamma scalping for me. You're never going to find a technique that works every time, so it's really about finding whatever is the most consistent in the long run. Let's review a few popular methods:
1. Technical Analysis: If you're fairly adept at identifying reversal points in a stock's price, you could certainly use charting to better identifying when a stock is poised to reverse course. This would be a logical time to gamma scalp to lock in any accumulated gains.
2. Fixed Intervals: If you shun the subjectivity of chart reading and prefer instead to take a more objective route you could opt to re-hedge at fixed intervals such as every time the stock rises or falls by one or two ATR's. Or perhaps adjust when your position delta changes a certain amount.
Thus far I've probably used a blend of both.
For related posts, check out:
Gamma Facts
Clash of the Greeks
Clash of the Greeks Part Deux
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