Options Delta Neutral Strategies
Hello WSO, I am interning at the CBOT learning about commodity options and I have a quick question about options strategies.
What is the fundamental difference between being Delta/Gamma Neutral compared to delta neutral long gamma? I know Delta/Gamma Neutral makes money off the change in volatility, which an increase in volatility means the price of the underling is changing. How would this be different from a Delta Neutral Long Gamma then?
Also why do Delta/Gamma Neutral positions not face any time decay?
It sounds like you need to take a couple steps back and go over fundamentally what delta/gamma/vega mean. Id answer the questions but it seems like you are very confused about a lot of fundamental ideas. Id highly recommend De Weets book "Introduction to Options Trading", very basic and a very quick read, but is great at breaking down the fudnamentals.
Also note gamma neutral positions are not necessarily theta neutral, but think about that understand why this point can be surprising.
What are some of the gamma neutral positions that have theta? I can't think of any. If there's any, I'd trade it all day to collect theta.
The effect is local and you have to assume some form of correlation between spot and implied vol. Not really something tradeable, more an interview question/thought experiment.
By eg shorting skew (in a ratio) you can easily construct a position where you are gamma neutral and receive theta. But as derivstrading points out, it's local. And in reality the carry you collect is nothing but the premium for selling a form of event risk. In a big down move you'll find yourself gamma short at the wrong time.
I second derivstrading on taking a couple of steps back.
In a nutshell: delta - change in option price for a discrete change in the underlying price gamma - change in delta for a discrete change in the underlying price vega - change in option price for a discrete change in the implied volatility epsilon - change in option price for a discrete change in dividends rho - change in option price for a discrete change in rates theta - time decay
Delta neutral / Gamma neutral : within a certain range your pnl will be stable relative to changes in the price of the underlying, and you hope to make money of your residual greek position (vega, theta eg). Delta neutral / Gamma long : you want the underlying to move, regardless of direction, enough to compensate the time decay you are probably paying
I understand the difference, but what I don't get is my understanding of vega is how likely the price of the underlying will swing in either direction. I don't know how this is fundamentally different then being delta neutral / gamma long.
Can you give me a situation where the vega of an option is low while the underlying is moving big?
Your question doesn't make a ton of sense but ill attempt to answer it... Ok so just so you're clear: VEGA is the option's sensitivity to a change in the volatility of the underlying. Delta is the options sensitivity to changes in the underlying price.
So vega is a derivative w.r.t volatility, and delta its w.r.t. price... there is noting "fundamentally" the same about them. And gamma is a second order greek so i would not worry about that until you have your head around the first orders.
I understand this explanation you provided thank-you. What I was trying to get at in the OP was if one is Delta Neutral/ Gamma Nuetral, wouldn't it be pretty similar to delta neutral / gamma long in that vega correlates to violent price movements?
And when we are Delta neutral gamma long don't we want violent price movements? So is DN GN just a lower risk/lower return version of Delta Neutral Gamma Long?
Honestly read the book.
What does "vega correlates to violent price movements" even mean?
Vega does is not correlated to large price movements, vega is how the option price changes when the stock volatility changes. You could have low vega or high vega with the same level of volatility in the underlying, For example:
1) You have a WAY in the money call - even if the stock price starts to move a lot (and volatility increases), your option price won't change that much since your already so far in the money.
2) You have an at the money call - now if the price of the underlying starts to fluctuate (higher vol), you will see the option price move more here then the call that was way ITM.
It would help if you would actually set out the full greeks of the two strategies you have in mind, as you leave a lot of parameters undefined. But I assume you're idea is to differentiate between gamma vs vega strategies.
Delta neutral + gamma long The easiest way to establish this position is to buy a short term call/put and selling/buying the delta. Or to keep things really simple regarding remaining greeks, buy a one day at the money straddle. Assume you manage this position statically, and only evaluate the outcomes at expiry. Either, the underlying moves sufficiently so that the pay off > premium paid. Or it doesn't. Simple as that. The amount by which the underlying needs to move is determined by the one day implied volatility you paid for it. Roughly, if you paid 16%, you'll need a 1% move to break even. If you paid 32%, you'll need a 2% move. Bonus question: if you paid 32% and the underlying only moves 1%, how much of your premium did you recover ?
Bottom line: if you establish a gamma long position you are doing so with the intention of benefiting from the realized volatility in the underlying.
Delta neutral + gamma neutral There are multiple ways to construct the above. One position that would give you such profile is to buy a long term (say 1 year) option and sell a shorter tenor (say 1 week). Any residual delta you hedge. You will be long vega, flat gamma. Whether you receive or pay theta will be determined by the implied volatilities of both options, but let's assume that your theta is 0 as well. Now, regardless whether the underlying moves up or down (within a reasonable range), your expected pnl is 0. If it doesn't move at all, it will still be 0. What will drive your pnl however is what happens to implied volatilities. Imagine following two possible scenarios; - short term volatilities spike, long term volatilies don't budge (eg Yellen/OPEC/company CEO announces a surprise press conference one week from now). You don't know what will be said, but suddenly the possibilty of a big move right on the expiry of the short tenor goes up. Implied 1 week vols will be bid as everyone wants to be long gamma for the event. No one really cares about the 1 year vol since it gives you very limited gamma and the expectation is that after the press conference everything will return to its usual state. That day you'll suffer a (small) mark to market loss since although you were vega long, it was the tenor that you shorted to remain gamma neutral that actually increased. All this with no move whatsoever in the market. - short term volatilities go down, long term volatilies go down (eg Yellen/OPEC/company CEO announces during a scheduled press conference exactly what was anticipated, cements the outline for the coming year) Market finishes unchanged and everyone believes the existing status quo will be maintained for eternity. Basically markets are boring and nothing happens. Short vols get hammered. Long term vols drift lower as well. Your position: on the tiny vega that is left in your short 1 week position you make some money. However, on your long 1 year position you are now bleeding and its pnl impact will be bigger than the one of the short option. Overall, you just lost money. This again without any move whatsoever in the market. Bonus question: in what kind of scenario would you actually make money ?
Bottom line: if you establish a vega long (or short) position you are doing so with the intention of profiting from changes in the expected/implied volatility. If you stay gamma neutral, you are indifferent to the realized volatility of the underlying.
No, everything you're asking indicates that you don't understand the difference. Why don't you actually take the advice and read the book that was recommended to you?
You'd better have the self-awareness to recognize what you don't understand if you hope to make it in trading.
Asked & answered.
I had my supervisor explain this to me I understand it now thanks guys! Any traders here in Chicago that would care to ever catch a lunch or something? I am at the CBOT and usually get out right before 1:30pm.
IMO, the kid is confused about realized vs implied volatility. If you're long gamma, you profit when realized volatility(actual movement) is big. If you're long vega, you profit when implied volatility rise.
And that brings us to one point of vol trading a surprising amount of interns skip over/dont think about and is a bit of an a-ha moment for them. Changes in implied vol and vega pnl is just the change in expected gamma pnl for the remaining life of the option. Fairly simple, but crazy how many kids dont make the connection between gamma and vega and just think they are these separate risks.
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