What does it mean when a trader says we are always long gamma?
From my understanding they are always in a position that an increase in gamma will benefit their position. This is typically associated with a position that loses value over time. I.e. Trader is long deep otm call, so there is a low delta/gamma. As the underlying moves towards the strike price the option’s gamma increases and the delta increases and the option value goes up. If the trader was short the otm call he would be short gamma.
Long gamma means that you have an option position where net gamma is greater than zero. This means that you make money based off movements in the stock. Suppose you’ve hedged your delta to zero buy buying or selling the appropriate number of shares. If gamma > 0, then if the stock rallies, than your Delta increases as the stock rises giving you a delta>0, which makes money. If stock falls, delta falls below zero, making you short the stock as it goes down. In either case, the position makes money (all else equal). Buy shares end of day if the stock fell or sell end of the day if the stock rallied and your back to 0 Delta with a nice scalp. Compare that to being short gamma. As stock falls, your delta becomes greater than 0 making getting you longer and longer on the way down, making you lose money on Delta. If stock rallies, Delta becomes < 0, making you short the stock on the way up, also losing money. End of day, if stock is up you have to buy shares to bring you back to zero, and if stock is down, you have to sell shares to bring you back to zero, creating an anti-scalp. Quiz: If you make money in either direction long gamma and lose money in either direction short gamma, why would you ever be short gamma?
ahahah Wrote: ------------------------------------------------------- > Quiz: If you make money in either direction long > gamma and lose money in either direction short > gamma, why would you ever be short gamma? You only make money if you are gamma scalping. If you are not buying/selling shares of the underlying this isn’t necessarily the case. It also assumes you are delta neutral. To your point though, you have to consider the effect of theta (time decay). When you are short gamma you are getting paid as time goes by (long theta?) and vice versa. I think what you’re getting at is for gamma scalping to pay off you have to have sufficient volatility of the underlying so the scalping profit compensates for the time decay. Right?
Being long gamma is good in my book. Gamma is one of the “option greeks” and if you’re a calculus type of person, it’s the second derivative of an option’s price with respect to the underlying price. Another way to think of that is that it’s the rate at which the price of an option accelerates (upwards) as the underlying’s price increases. In most situations, the farther an option moves into the money, the faster the speed at which the option makes money. In practical terms, this means that large unexpected jumps in the price are going to make more money than you would normally think, on the order of gamma*(price change)^2. It’s the squared term that leads to substantial gains or losses in large jumps. Reading “Inside the House of Money” on global macro trading, one of the themes that jumps out is that almost all of them are very averse to “negative gamma.” Negative gamma basically means that large unexpected changes in prices will loose substantial sums of money (basically increasing with the square of the jump). People who are used to calm, low volatility environments tend to be “short gamma,” or have “negative gamma” exposure (same thing). Basically, they make money by selling options to people who are afraid of large moves and charging an extra premium for that. But any time things suddenly get volatile, they get majorly whacked. It’s been a good money making strategy from about 2004-2007. It’s been pretty tough going since Aug 2007. You might wonder why anyone would sell an option, given the risk characteristics. One of the reasons is that you can somewhat hedge your exposure with delta hedging. Basically, the value of an option after a price change can be approximated by: Option Price Change = delta*(underlying price change) + gamma*(underlying change)^2 You can reduce your exposure to price changes by holding (delta) shares of underlying for every 1 call option you sold (you short shares to hedge a put). However, it’s very hard to hedge the gamma part of the equation, so when there are large jumps, delta hedgers get whacked. They make up for it a bit by making payees pay for a higher implied volatility than they are actually expecting real volatility to be, but with large moves, the squared term can quickly overwhelm even this cushion.
LPoulin133 Wrote: ------------------------------------------------------- > ahahah Wrote: > -------------------------------------------------- > ----- > To your point though, you have to consider the > effect of theta (time decay). When you are short > gamma you are getting paid as time goes by (long > theta?) and vice versa. I think what you’re > getting at is for gamma scalping to pay off you > have to have sufficient volatility of the > underlying so the scalping profit compensates for > the time decay. Right? exactly The entire game of short dated option trading is “will gamma beat theta?”.
bchadwick Wrote: ------------------------------------------------------- > Being long gamma is good in my book. > > Gamma is one of the “option greeks” and if you’re > a calculus type of person, it’s the second > derivative of an option’s price with respect to > the underlying price. Another way to think of > that is that it’s the rate at which the price of > an option accelerates (upwards) as the > underlying’s price increases. > > In most situations, the farther an option moves > into the money, the faster the speed at which the > option makes money. In practical terms, this > means that large unexpected jumps in the price are > going to make more money than you would normally > think, on the order of gamma*(price change)^2. > It’s the squared term that leads to substantial > gains or losses in large jumps. > > Reading “Inside the House of Money” on global > macro trading, one of the themes that jumps out is > that almost all of them are very averse to > “negative gamma.” Negative gamma basically means > that large unexpected changes in prices will loose > substantial sums of money (basically increasing > with the square of the jump). > > People who are used to calm, low volatility > environments tend to be “short gamma,” or have > “negative gamma” exposure (same thing). > Basically, they make money by selling options to > people who are afraid of large moves and charging > an extra premium for that. But any time things > suddenly get volatile, they get majorly whacked. > It’s been a good money making strategy from about > 2004-2007. It’s been pretty tough going since Aug > 2007. > > You might wonder why anyone would sell an option, > given the risk characteristics. One of the > reasons is that you can somewhat hedge your > exposure with delta hedging. Basically, the value > of an option after a price change can be > approximated by: > > Option Price Change = delta*(underlying price > change) + gamma*(underlying change)^2 > > You can reduce your exposure to price changes by > holding (delta) shares of underlying for every 1 > call option you sold (you short shares to hedge a > put). However, it’s very hard to hedge the gamma > part of the equation, so when there are large > jumps, delta hedgers get whacked. They make up > for it a bit by making payees pay for a higher > implied volatility than they are actually > expecting real volatility to be, but with large > moves, the squared term can quickly overwhelm even > this cushion. This is very informative bchadwick. Thanks for being such a great asset to this board.
This board has been great for me; it’s nice to be able to give back. And I learn from all the other discussions too. My consulting is a bit slow these days, and permanent hiring seems to have gone off-line, so I’ve been writing more here lately.
Being long gamma is also used in the fixed income world to indicate that you are long a bond with positive convexity. This is also referred to as being long volatility. In the credit world, you are often short gamma because you hedge the treasury component of your bond with a short on the treasury. Because a corporate bond will typically carry negative convexity, your hedge may not be ideal because the treasury will have a greater level of convexity, and thus…you are short gamma.
A nice discussion here. bchadwick, mib20, good informative posts, thanks. My 2c: If you write options (i.e., are short gamma), high gamma also means you have to rebalance your hedge more often. bchadwick mentioned traders adverse to “negative gamma” - were those guys delta hedging but not gamma hedging? Sounds like there might have been. I thought gamma hedging is not that hard, you just use other options to hedge (as opposed to the underlying) but I guess it does add complexity to managing a book. mib20: “corporate bond will typically carry negative convexity…” - is that because you are thinking these would be typically callable?
> This is very informative bchadwick. Thanks for being such a great asset to this board. +1
f8ck derviatives i hate studying for that sh8t