What Other Bloggers are Saying

 

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I've often mentioned that I avoid trading near-term options, especially as expiration draws near.  My primary reason:  Negative gamma increases, and that's more risk than I want to accept.

If you are interested in a bit more detail as to why this phenomenon occurs, Jared at CondorOptions and Steven at Investing With Options recently disucssed how time to expiration affects delta (charm) and gamma (color).

If those terms: charm and color are unfamiliar, Wikipedia offers definitions for readers who want a more mathematical description.  Charm and color are among the less well-known Greeks.  They are not Greek letters, but are considered to be options "Greeks."

Charm or delta decay, measures the instantaneous rate of change of delta over the passage of time.  Charm can be an important Greek to measure/monitor when delta-hedging a position over a weekend. Charm is a second-order derivative of the option value, once to price and once to time. It is also then the (negative) derivative of theta with respect to the underlying's price.

Color or gamma decay  measures the rate of change of gamma over the passage of time. Color is a third-order derivative of the option value, twice to underlying asset price and once to time. Color can be an important sensitivity to monitor when maintaining a gamma-hedged portfolio as it can help the trader to anticipate the effectiveness of the hedge as time passes.

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Jared concludes: "Delta decay is of particular interest to traders holding ATM or OTM options near expiration, especially when those options are serving as portfolio hedges."

Steve puts it this way: "So we know that gamma increases in magnitude over time. This is known as charm. So if you are selling puts with 5 weeks left, you will have less overall “heartburn” than if you sell puts with 5 days left. The tradeoff is less theta, but that’s for another post."

 

For more detail refer to these posts.  I understand that this is the Options for Rookies blog.  If the idea of charm and color feel too advanced, all you really have to know is that gamma increases as expiration approaches, and that holding short option positions into expiration comes with extra risk.  I know you have heard that idea before.

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5 Responses to What Other Bloggers are Saying

  1. Roberto 10/06/2010 at 9:40 AM #

    Hi Mark,
    almost every successful trader talks about daily routine (search for trades, manage existing trades, study, acquiring news and so on…), what can you tell us about it?
    Can you describe more or less your typical daily routine as a trader?
    Thanks
    Regards
    Roberto

  2. Mark Wolfinger 10/06/2010 at 10:28 AM #

    Roberto,
    My routine is not that of the trader you describe – that’s the day-trader or perhaps a swing trader. To me those guys trade stocks, not options. Why? Options have bid/ask spreads that are too wide for constant in and out trading.
    Someone who opens option positions and hold for weeks or months as I do, has no need for a daily routine to find new trades. When I have margin room and when I want to open a new trade, I can readily find ideas.
    I trade only one underlying asset and am able to select the best trade for my needs when necessary. No study required.
    I ignore all news. It means less than zero to me. I follow no stocks and don’t care which ones rise/fall.
    I manage risk carefully. But, as an iron condor trader, most days require no thought. I have a trade plan. I have an idea of what I will do when necessary. If ‘when’ arrives, I follow my plan or reconsider – if the market is calm enough to give me time to consider adjustment alternatives.

  3. Roberto 10/06/2010 at 10:49 AM #

    Thanks for sharing.
    Roberto

  4. D 10/07/2010 at 7:42 AM #

    Hello Mark,
    I have a few questions on delta neutral/gamma neutral strategies.
    1- If I expect a change in volatility, how can I construct a delta neutral/gamma neutral option position so that a move in the underlying does not affect the position?
    2- Can I construct this position only using options (in other words, can I construct this position without having to buy or sell shares of the underlying stock to make the position delta neutral)?
    3- After I enter the trade, will I need to keep adjusting this position to keep it delta neutral/gamma neutral? Or it it that, once the position is constructed in such a way that it is delta neutral/gamma neutral, it will remain that way and no adjustments will be necessary? If that is not the case and adjustments are necessary, what would be an indication that an adjustment is necessary?
    4- Could you please provide some examples of how to construct this type of strategy?
    Thanks!

  5. Mark Wolfinger 10/07/2010 at 8:18 AM #

    Hello D,
    One problem that I frequently confront is a complex question – with no idea of who is asking. One time I gave a lengthy, difficult reply, only to discover that the questioner was a total novice who did not really understand his question.
    So I ask: Are you a beginner, or are you a very experienced trader, looking to refine a successful system?
    1) I don’t know. Gamma and delta neutral trading is not something I have ever considered on my own. When I worked for a trading firm, we had software scan for, and find such positions. But they never remained neutral as the stock moved.
    2) Yes. If you need gammaless delta, buy deep ITM options. This is always better than using stock.
    3) It will not be gamma/delta neutral forever. Yes, you will have to make changes – depending on just how neutral you want to be. Neutral does not have to mean 0.00
    To remain neutral, the next level of derivatives must also be neutral: charm and color. The math of this is beyond me.
    An adjustment is necessary when delta or gamma moves far enough away from zero that you want to move it back to zero. Thus, there is no exact answer.
    4)Sorry. I don’t know how.
    If you are trying to build a position so you can play vega and eliminate all other risk, this is not an efficient way to do it. My guess is that it will be require a significant number trades with lots of legs, lots of commissions, difficult to enter because of a lot of slippage, and difficult to exit.
    Where is your profit potential?