vol trading
These questions will probably draw both criticism and genuine sincere replies - I welcome both and thank you for your time in advance.
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How do you make money trading vol? You're making money between realized vs implied, but how does this actually monetize? I understand that vega has something to do with this, but can someone give a simple explanation on how you convert vol to actual money at expiry?
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What exactly is gamma and vega trading and why is gamma trading associated with short term and vega trading with long term?
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If you are long AAPL 3M ATM CALL and you have one month left before expiry, how do you unwind this position if you choose not to unwind with the original counterparty - do you sell a 1M C ALL option with your strike, is there another way to offset this position?
Once again, thanks for your reply in advance.
buy/sell bull straddles when vol is cheap/expensive
1) If you thing implied vs. realized (xx day rolling vol) is mispriced, you can buy/sell the option and delta hedge (sell/buy the underlying in accordance with your delta).
eg. Long vol : Buy ATM call option, sell 0.5 worth of underlying (assuming 0.5 delta). Of course this means you have to rebalance your hedge.
2) In the above scenario you have positive gamma. When underlying price goes up, you make more on your option than you lose on your hedge. You can scalp gamma this way. Incidentally most market makers have negative gamma, which can explain the large swings in the market sometimes.
eg. Negative gamma basically means they wrote a bunch of options. Say they wrote a call, bought the underlying to delta hedge. Price moves up, Call's MTM increases more than underlying hedge -> buy more to hedge delta -> force underlying higher.
3) AAPL 3M options are exchange traded... so can just sell them. Your solution would be good since you can earn theta, any other way would see the time value being lost.
Not sure if I was very clear, but I'm a little drunk... so anyone please fill in the gaps
@ivoteforthaguy, thanks. So let's say I long atm stdl because I think IV is cheap compared to my vol forecast. I keep it delta neutral and offset theta by scalping delta so that my biggest exposure is vega. Say I am correct at expiry vol realizes 3% higher than when I bought it, how do you monetize 3%?
@monkeymark, thanks. Same as above, I am hedged against the other greeks, only real exposure is vega. How does this monetize at expiry?
it's monetized throughout the life of the trade. Say you pay 10,000 USD for this straddle, when you're buying the underlying low/selling underlying high (i.e. trading long gamma), you'll naturally be making money by doing this.
(e.g. straddle at strike of 100. the underlying stock trades up and down through 100, multiple times. so as an example, you buy at 97, sell at 103, buy at 97, sell 103 as the underlying just whips back and forth through your 100 strike). So if there was indeed sufficient volatility to allow you to buy low/sell high often enough... you will have made more than 10,000 USD in your delta hedging. That's how its monetized.
To your 2nd question... Gamma is associated with short term structures because as you know from your options theory, shorter dated options have more gamma/less vega... and longer dated options have less gamma/more vega.
So as an example, if you buy a 1 week straddle, you're not really going to be making money from changes in 1 week implied vol (i.e. vega), you'll make money from large swings in the underlying (and monetize it by delta hedging multiple times ...i.e. gamma trading)
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