Gammatron

Vol #204: November 21st, 2024

Gamma used to be a bigger deal.

These days at the water cooler, it’s all about the higher order greeks. Vanna strutting her stuff, with Volga and Vomma goons there just to look spooky. 

It’s not calculus, but to me gamma always had a visceral meaning of “what happens when shit moves”.  Isn’t that why you traded derivatives? Learning about options through the lens of a market maker, deltas were a thing to manage robotically and shouldn’t be a source of PnL. The risk you managed was what happened when everything changed. 

Long gamma option owners want the underlying to move because they pick up more directional risk the further stock goes. Short gamma of course wants the opposite - your deltas get worse for each tick away. 

Owning a simple at the money option, a little bit of move sees a lot of percentage change in value. That curvature we all want. A position has the most gamma here and that will be a big driver of PnL. Picking up deltas quickly in early action.  As you move further and further away from the strike, gamma’s impact slows down, and a long option just starts to look like boring old stock.

Depending on the complexity, gamma can give you deltas in all kinds of funny places. With legs across both strike and time, movement isn’t so simple. Turn an at the money call into a call spread, and as we move away from the money the short strike becomes more important. 

Long a $5 vertical sitting right at your short strike - the intuition matches your short gamma position. You don’t want stock to move, let’s all take a deep breath, settle, and expire into maximum value. 

If stock drifts right back down, a $2 debit formerly marking at $4.50 ultimately expires worthless. The sands of time, and your profits, have passed right through your fingers. 

By purchasing options and getting long gamma, you’re paying the upfront cost of potential energy. That’s why the other side of gamma is time decay. That spread could have been - and nearly was - worth $5. Sadly, time on the clock let a bit more movement happen. 

Most options charts only show the PnL at expiration, but anyone with a margin account knows there’s a lot more that happens between the bells. The price of movement (theta for gamma and vice versa) is not just for the coin flip of where stock lands in two Fridays - you’re buying every tick in between.

Short option holders know those ticks well. Collecting a credit on an iron condor, there is nothing more agonizing than the meaningless flows that push your position around. 

The flip side of gamma is theta - earn it by sitting on your hands, or pay up for the possibility. 

Whichever side of the coin you're sweating, most positions have a wide range of values before their terminal one. There’s very little to do if you’re short but remind yourself that VRP is an edge. But if you’re long, you want to make those ticks work for you. 

In the timeline of trading tools development, before I used an automated hedge, there was a program to scalp gamma. Catching that movement paid the theta bills. If you have a long gamma bias, waiting for everything to be a home run is a tough way to keep the lights on. 

Gammatron was a clunky but highly effective tool. In a hybrid world of open outcry and gradual electronification, position changes were significantly less frequent. Overall contract volumes were a fifth of what they are today, orderflow was chunkier, and there were fewer strikes to trade on. 

That didn’t mean stocks moved any less. While there might not have been as many offsetting orders coming down the pike, a 50 vol stock still moved your greeks around like a 50 vol stock. 

To help tread water and offset the impact of the theta bill, traders could put their stocks on Gammatron. This simple logic ran on the position server, and layered out orders at predefined breakpoints. Punch in a ticker and a gamma value, and it would scale buys and sells to trade out of the deltas you picked up. 

The catch to doing this is setting the right level. If you make the channels too wide, you miss the movement.  Too narrow and you’re selling out/buying in too early. But with some back of the envelope average daily move calculations, Gammatron was very helpful in monetizing the longs. 

Gammatron fell into a pile with Atari as individual traders took more of a role in stock hedging. There wasn’t just a single Instinet connection, every station had 5 different brokers plugged in and ready to send VWAPs, Sniper, or Pounce orders. 

As trading activity increased, it also negated - or rendered significantly more complex - the ability to scalp gamma. The best thing you can do with the long gamma call you own for edge is sell out something similar for edge to offset your position. Gammatron simply saw the world in straddles and stock shares. 

Liquidity provider positions are constantly changing - that makes it hard to account for all the places you’re supposed to be scalping gamma or sitting tight. Fortunately activity means edge, so you don’t have to exert yourself treading water. 

For options investors at home, constant turnover is not your friend. While the GULL structure to hedge equity might have a non zero gamma value, necessary adjustments are rare - by design!

If you’re trading an active portfolio, credit structures still get paid for sitting tight. They can benefit from movement to lock in profitable legs, but mostly buying high and selling low is going to hurt you. 

Looking at the board, there’s always something cheap. Sometimes options are ripe for purchase, and you find a short dated long gamma opportunity. Now you have lots of decisions to make about how to monetize different degrees of movement.

If you’re long a straddle, get your scales ready. With more complex structures, it’s going to depend on where price is, relative to different longs and shorts. In either case, appreciate long gamma for the hot potato it is. Owning options can be an expensive habit if you’re not taking advantage of everything they’re worth.