If it keeps on raining, gamma's gonna break

Fifty Ways to Trade an Option

And when the gamma breaks, mama you’ve got to move…

Led Zeppelin gets flak for not having written many of their own songs, but there’s no shame in cribbing a classic trading strategy.

The past weeks have been a crucible for many strategies. Short volatility exploded, deltas dipped and ripped, and even bonds and forex weren’t immune to the carnage. Longs are extremely expensive and difficult to justify, while shorts have a mind of their own.

We talked last week about long volatility via VIX options. When stocks go down you can theoretically make money by being exposed to the increase in implied volatility. But as we saw, it’s very difficult to get the monetization timing right. It’s also a little bit abstract - thinking about annualized moves and forward prices of expectations.

When volatility is looking you right in the face, it’s more like gamma. When trading short dated options, while the implied volatility matters, what’s really more informative is the straddle price. If you’ve got long straddles in your pocket, stock needs to move more than that to earn your keep.

But when you’re paying up for premium - particularly at these prices - a simple straddle holder can’t just be content with waiting until the final mark. The theta bill that is getting charged every minute includes not just the price of movement between the current mark and expiration, it charges for every little move in between.

Publishing this before Friday’s close will certainly make me wrong, but we’ve seen nearly a 700 point range in the SPX so far. Currently we’re set to close up roughly half that. A pure straddle play is basically flat, even after multi sigma moves.

Today in Fifty Ways to Trade an Option, we’ll look at how to manage a gamma hedging strategy around a long straddle, and what kinds of parameters to consider when monetizing long premium.