What are the characteristics of this option strategy?
Gamma scalping pairs a long option position with continuous trading in the underlying stock. The option leg, usually a long straddle or another long-gamma structure, is held while the shares are bought and sold in rapid succession as the price moves. The goal is to profit from realised volatility rather than implied: the trader delta-hedges the option position in the underlying, selling shares as the price rises and buying them back as it falls, so that each round trip banks a small profit. Those scalps have to add up to more than the premium and the theta paid for the options, or the trade still loses.
Is this a bullish, bearish or neutral strategy?
Gamma scalping is a neutral strategy, meaning that it is independent of the direction of the market. The position is kept close to delta neutral by the hedge, so it does not care which way the stock goes. What it needs is movement: the profit comes from the size and frequency of the swings, that is from realised volatility, not from a directional view.
Is this a beginner or an advanced option strategy?
Gamma scalping is an advanced option strategy. It is a complex strategy that requires considerable knowledge of options markets, market internals, and the timing of market moves. New traders should be familiar with some of the basics of options trading before attempting this strategy.
In what situation will I use this strategy?
Gamma scalping is most often used when the underlying stock is expected to swing repeatedly and by more than the options market has priced in. It is common among market makers, who end up long gamma from customer flow and hedge that inventory in the underlying rather than taking a view on direction. What the trade needs is choppy, high-amplitude movement in both directions, not a single one-way move.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The goal of gamma scalping is to make small profits from rapid moves in the underlying price. As such, the risk-reward and probability of profit will vary depending on the exact structure used. The reward per scalp is small, but the risk is the entire premium paid plus hedging costs, and the trade only wins if realised volatility exceeds the implied volatility paid, so the probability of success is not high.
How is this strategy affected by the greeks?
The greeks will have an effect on the pricing of options when used in this strategy. Delta, theta, vega and gamma will all impact the profitability of the strategy. Therefore, it is important to have an understanding of the greeks before implementing this strategy.
In what volatility regime (i.e VIX level) would this strategy be optimal?
What matters is not the absolute VIX level but the gap between realised and implied volatility. The position pays when the stock actually moves more than the implied volatility priced into the options it bought, so a VIX above 20 helps only if the underlying delivers swings large enough to cover that premium. Buying options into an already elevated VIX and then seeing the stock sit still is the standard way this trade loses money.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjustments will depend on the exact strategy being implemented. Generally, adjustments are made by rolling out the current position and taking an opposing position on a different strike price. This strategy can be difficult to adjust, as adjustments must be made quickly in order to take advantage of the fast-moving markets.
Where does this strategy typically fall in the range of commissions and fees?
Gamma scalping requires frequent trading, so commissions and fees can quickly add up. It is important to consider what types of accounts you have access to and the associated fees before committing to this strategy.
Is this a good option income strategy?
No. Gamma scalping is a long-premium strategy, not an income strategy. It pays theta out every day rather than collecting it, so the scalps have to earn back that decay before anything is left over. There is no guarantee of profit and the full premium paid can be lost. Understand the risks and the hedging costs before attempting this strategy.
How do I know when to exit this strategy?
As with any trading strategy, timing the exit is essential for success. Exits should be based on the underlying stock price, volatility levels, and the trader’s objectives.
How will market makers respond to this trade being opened?
Market makers generally do not care if this strategy is used or not. They will not be able to predict the direction of the underlying stock, as the strategy is market neutral.
What is an example (with calculations) of this strategy?
Here’s an example of gamma scalping using the stock MSFT, which is trading at $285:
Assuming that we expect MSFT to swing around more than the options market is pricing in, we could use gamma scalping to profit from that movement. Note that what we need is repeated movement in both directions, not one big move in a single direction. In this case, we could set up the following trade:
Buy 1 MSFT call option with a strike price of $285 for a premium of $10.00
Buy 1 MSFT put option with a strike price of $285 for a premium of $10.00
The total cost of this trade is $20.00 per share, or $2,000 for one contract of each. That premium is the maximum loss on the option legs, and it is money already spent: the scalps have to earn it back before the trade is ahead.
At $285 the two options roughly cancel out, so the position starts close to delta neutral. The scalping is done in the stock, not by selling the options.
If MSFT rises to $295, the call picks up delta faster than the put loses it, and the position is now long roughly 30 deltas. We sell 30 shares at $295 to flatten back to neutral. If MSFT then falls back to $285, the position is short deltas again, so we buy those 30 shares back at $285. That round trip banks 30 x $10.00 = $300 in cash while leaving the option position intact.
If MSFT instead falls to $275 first, the put picks up delta and the position is short roughly 30 deltas, so we buy 30 shares at $275 and sell them again if the stock recovers to $285, for the same $300.
Each swing is scalped this way. The catch is that the straddle loses value to time decay every day it is held, so the accumulated scalps have to exceed both the $2,000 premium and the commissions on all that share trading. If MSFT simply sits near $285, there are no swings to scalp and the position bleeds out.
MarketXLS and how it can help
MarketXLS is a powerful tool that makes analyzing and trading options a breeze. With MarketXLS, you can easily calculate option greeks, such as delta, gamma, theta, and vega, as well as monitor real-time option prices. MarketXLS also gives traders access to real-time news and research, so they can make informed decisions quickly. With the help of MarketXLS, traders can take advantage of gamma scalping quickly and easily.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic