Sep 24 Gamma hosted by Tom Preston

(tpreston): Good afternoon everybody

(tpreston): It's time for our weekly online seminar

(tpreston): This week we'll cover gamma and gamma scalping.

(tpreston): I'll cover the material in about 20 minutes or so, then I'll open it up to
questions.

(tpreston): Remember that delta measures how much the theoretical value of an
option will change if the underlying stock moves up or down $1.00.

(tpreston): Gamma measures how much the delta of an option will change if the
underlying stock moves up or down $1.00.

(tpreston): You can use gamma as a way to see how “stable” your delta is. For
example, if you have a large gamma, your delta will change quickly if the stock price
changes.

(tpreston): The gamma that you see in the Position Statement of the Monitor page is
the net gamma of your positions.

(tpreston): It multiplies each option's theoretical gamma (which you can see on the
TRADE page) by the quantity of options and by 100 (which represents the number
of shares for a standard option contract), then adds them together.

(tpreston): So, if you buy 5 XYZ Oct calls with gamma of .10, the position gamma
would be 50.

(tpreston): The way to interpret position gamma is that if the stock moves up $1.00,
the position delta would theoretically increase by 50, and if the stock moves down
$1.00, the position delta would theoretically decrease by 50.

(tpreston): Long calls and puts have positive gamma. Short calls and puts have
negative gamma. Stock has zero gamma, because the delta of stock is constant at
1.00.

(tpreston): For calls, positive gamma means that their delta will become more
positive and move toward +1.00 when the stock prices rises, and less positive and
move toward 0.00 when the stock price falls.
(tpreston): For puts, positive gamma means that their delta will become more
negative and move toward –1.00 when the stock price falls, and less negative and
move toward 0.00 when the stock price rises.

(tpreston): The reverse is true for short gamma.

(tpreston): A good way to think of gamma is that it "manufactures" deltas, and that
if your position is long gamma you generally want the stock price to move, and if
your position is short gamma you generally want the stock price to sit still.

(tpreston): For example, if you are long an XYZ Oct 50/60/70 call butterfly with the
stock at $60. That position is short gamma, and makes money if the stock price
stays where it is.

(tpreston): You can see the gammas of individual options by going to the TRADE
page, and selecting "gamma" from the Information Layout menus in the upper
right hand corner.

(tpreston): Gamma is highest for at the money options, and becomes smaller as
options are in the money and out of the money. This means that the delta of at the
money options changes the most when the stock price moves up or down.

(tpreston): The values of gamma look like a hill, with the at the money strike at the
peak, and the out of the money sloping down from the peak.

(tpreston): The way time passing and changes in volatility affect gamma depends on
whether the option is at the money or out of the money.

(tpreston): Time passing or a decrease in volatility acts as if it's pulling up the top of
the hill on the graph of gamma, and making the slope away from the top steeper.
What happens is that the at the money gamma increases, but the out of the money
gamma decreases.

(tpreston): An increase in volatility pushes the at the money gamma lower, and the
out of the money gamma higher.

(tpreston): The gamma of the call and put at the same strike is nearly equal. Let's
use an example to see why.

(tpreston): Let's say the XYZ Oct 50 call has a delta of +.45, and the XYZ Oct 50
put has a delta of -.55, with the price of XYZ at $48.00. Note that the absolute
values of the deltas at each strike add up to approximately 1.00, no matter what the
stock price is.

(tpreston): The gamma for both the XYZ Oct 50 call and put is .07. If XYZ moves
up $1.00 to $49.00, the delta of the XYZ Oct 50 call becomes +.52 (+.45 + .07), and
the delta of the XYZ Oct 50 put becomes -.48 (-.55 + .07). The absolute values of the
deltas add up to 1.00.

(tpreston): If XYZ drops $1.00 to $47.00, the delta of the XYZ Oct 50 call becomes
+.38 (+.45 - .07), and the delta of the XYZ Oct 50 put becomes -.62 (-.55 - .07).
Again, the absolute values of the deltas add up to 1.00.

(tpreston): Because the deltas of the call and put move in proportion to each other,
their gamma is roughly equal.

(tpreston): Gamma Scalping is the name of a strategy that is best described by an

example.

(tpreston): Let's say IBM is $90, you buy 10 IBM Nov 90 straddles, and the position
has a delta of 0, and a gamma of 100.

(tpreston): If the stock rallies $1.00, your position will theoretically have a delta of
100. You could sell 100 shares of IBM at $91, making your position delta 0. If the
stock drops $1.00 back to $90, your position will theoretically have a delta of -100.
You could buy 100 shares of IBM at $90, making your position delta 0 again.

(tpreston): You just sold 100 shares at $91 and bought them back for $90, making
$100. You still have your long 10 Nov 90 straddles. That's "gamma scalping". The
long gamma manufactured the deltas, and you hedged the delta with a stock trade.

(tpreston): The risks are time decay and drops in implied volatility. Also, as the
stock moves away from the strike price, the gamma decreases, giving you less
movement in the delta when the stock moves.

(tpreston): You hope that the money you make from scalping the stock will offset
the money lost from time decay.

(tpreston): If your gamma gets reduced by the move in the stock, you can get your
gamma back up by rolling one or both of the options to the at the money options.
You would do that by selling a vertical.

(tpreston): Which month you select to gamma scalp depends on what you're
speculating on. If you think implied volatility will rise, you want the biggest vega.
That would mean an option with more days to expiration. But those have lower
gamma and time decay.

(tpreston): If you are speculating on a big move in the stock in a short time, you
want the biggest gamma. That would mean an option with fewer days to expiration.
But those have the biggest time decay also.
(tpreston): For many traders, the money made from scalping does not offset the
money lost from time decay.

(tpreston): You can also scalp by trading options.

(tpreston): On a rally, you can sell calls, then buy them back when the market
drops. That would reduce your time decay for the time that you sold the calls until
you buy them back. But it also reduces your gamma and vega, which may not be
what you want to do.

(tpreston): When gamma scalping, the more the stock moves between "scalps", the
bigger the profits of the scalps, but also the bigger the risk.

(tpreston): For example, if you wait for IBM to go to $92 before you hedge, sold
stock at $92, then waited for it to drop back to $90 before you covered the stock, the
profit would be greater.

(tpreston): But the bigger the stock moves, the bigger the accumulated delta. If you
wait to hedge, the large delta can hurt you if the stock moves against you.

(tpreston): At $92, your position delta might be +200, and if you didn't sell your
stock to hedge, and the stock dropped, you would give back all your profits.

(tpreston): That's why it can be very tough to make money gamma scalping.

(tpreston): OK, I'll open it up to questions now.

chrisjusti: if all your doing is making up for time decay, how do you make money at
this?

(tpreston): If implied vol rises, or if you get huge moves in the stock price in a short
time.

(tpreston): It depends on which straddle you have.

wdegaude: do you know of any good article on the subject to read about it?

(tpreston): There isn't really much good literature on gamma scalping.

felixf: Is the shape of the gamma 'hill' a Gaussian (normal) distribution?

(tpreston): The distribution of gamma is closer, I think, has fatter tails than normal
distribution.

meo777: When the overall market volatility is low, like it is right now, isn't it that
much harder to make money this way?
(tpreston): With implied vol low, it means the straddles are cheaper, but also that
large stock moves are less likely. The two offset. So it's not necessarily easier to
make money gamma scalpling when vols are high.

llangman: what sort of change in delta or gamma levels do people ten to use for
triggering a scalping adjustment?

(tpreston): When you do the scalp is up to you as a trader. You are really betting on
the direction of the stock. If, for example, you are confident that the stock might
continue to rise, you might not sell the stock to hedge as quickly.

fluxsmith: Can scalping be done profitably with a negative gamma option position?

(tpreston): Negative gamma scalping is the exact opposite. You short a straddle and
hedge the deltas as the stock moves against you.

(tpreston): It's not necessarily better, because the stock can gap against you and
wipe you out, offsetting any time decay you've accumulated.

meo777: been there

felixf: The candidates I've looked at for gamma scalping tend to have pretty high
implied vols, even in this low-VIX environment (50-80%). What vols do you look
for in a gamma scalping candidate?

(tpreston): I haven't seen any correlation between implied vol levels and success at
gamma scalping. When implied vols are high, the straddles get more expensive.
That means you have more risk if the stock just sits at one price and doesn't move.

(tpreston): There's never any "free money" in gamma scalping.

felixf: The relatively higher cost of the straddles at the high imp vol levels is exactly
what's been bugging me. :)

(tpreston): It tends to sound a lot better on paper than it is in real trading.

llangman: I know someone who is using a delta neutral/gamma scalping position on

a very lowvolatility stock - with the goal to make moneyon a spike in volatility. Does
this soundlike a logical way to try to make money on a volatility spike - whenever it
happens...

(tpreston): Sure, as long as you have a long straddle that has enough vega to profit
from the spike in vol.
marginman: If u already placed IBM straddle at 90, stock moved to $91, delta just
increased 100, what is the advantage of selling IBM stock over just selling enough
calls to bring delta back to neutral?

(tpreston): Selling stock preserves your gamma and vega exposure.

stj1010: Will monitoring the gamma of the gamma help keep you out of trouble?

(tpreston): Monitoring gamma lets you see how your delta will act. If you like your
delta exposure, check the gamma to make sure it won't change much if the stock
moves.

(tpreston): If you don't like your gamma exposure, you have to use options to hedge
it, because stock has 0 gamma.

felixf: In terms of selecting the expiration month, you mentioned that fewer days to
expiration is good if you expect a big move soon. Could you elaborate?

(tpreston): Fewer days to expiration means gamma is much higher. If the stock
moves big, the extra gamma will manufacture more deltas in your favor faster than
options with many days to expiration.

felixf: Ah yes. Thank you. So a drug company with a pending FDA approval/denial
would work well for this...

meo777: Regarding volatility, I am cornfused. Today the OEX has dropped

precipitously,
yet the VIX has hardly moved.Is this another exception to the rule day?

(tpreston): yes. There is no guarantee that the VIX and OEX are negatively
correlated.

meo777: "The only thing theory ever proved was that your pencil was working."

xqz8cg: why gamma is much higher in fewer days to exp?

(tpreston): At the money gamma is higher because it's more certain which options
will have value at expiration.

(tpreston): When there is more certainty, the options’ deltas will move faster to 1.00

(tpreston): When there is more certainty they won’t be in the money at expiration,
the options’ deltas will go to 0 quickly.

(tpreston): So, the options deltas change quickly if they are the ones that will have
value at expiration.
(tpreston): So, their gamma is higher.

xqz8cg: But in either case(ITM or OTM), gamma will be higher near exp?

(tpreston): No, out of the money gammas are lower at expiration, because it is more
certain they will have no value at expiration.

(tpreston): Those options’ deltas don't move very much.

felixf: What in your eyes makes a good gamma scalping candidate? Same criteria as
a straddle-strangle candidate?

(tpreston): Personally, I don't think gamma scalping is a great strategy. So I don't

think there are any criteria for finding good candidates.

(tpreston): Gamma scalping ultimately means you're guessing on the moves on the
stock.

felixf: But doesn't gamma scalping work if the stock moves in either direction?

(tpreston): If the stock moves in one direction, i.e. a trend, then gamma scalping will
be continuously selling stock into a rally.

llangman: this forum is great! Do you know next week's topic?

(tpreston): We'll post next week's topic on www.thinkorswim.com

(tpreston): For transcripts of the chat, send an email to

tradedesk@thinkorswim.com

meo777: Thanks, Mr. Preston good luck

msadollah: thanks this helps a lot

felixf: Thanks for educating me on gamma. You were terrific as always! :)

(tpreston): You're welcome.

(tpreston): See you next week!