What values of gamma do you consider as high?
When I am looking at my brokerage
account I have the same questions- what is considered high
(risky) Gamma and what is low (safe) amounts of negative Gamma.
what you say about Gamma, is there a method of factoring in the effect it
has so that it is used to advantage when trading or adjusting?
When using options, there are many strategies that a trader can adopt. Some come with positive gamma and positive curvature (risk graph = smile) and the trader makes money as the underlying makes significant moves. One benefit that comes with these positions is the absence of tail (unlikely event) risk. In fact, black swan events offer substantial rewards when the trader has both upside and downside curvature.
The cost of owning such positions is the daily time decay in the value of those options.
- Buy calls or puts
- Buy calls and puts (strangle, straddle)
- Back spreads (more options are bought than sold)
Other strategies come with negative gamma, negative curvature (risk graph = frown), tail risk and positive time decay. The trader who prefers this type of trade usually takes precaution against tail risk by owning positions with limited losses – i.e., no naked short options. Nevertheless, a big market move is the enemy and the trader loses money when the underlying moves too far (or too fast).
- Naked short options
- Covered call writing
- Credit spread*
- Iron condor*
* Limited loss strategy
Delta represents the anticipated change in the price of an option when the underlying moves one point.
Gamma represents the anticipated change in delta when the underlying moves one point. And gamma is not constant and also changes as the underlying changes.
When short (long) delta in a rising (falling) market you expect to lose money. However, gamma makes it worse. With negative gamma, delta accelerates and losses accrue more rapidly.
This is why I believe adjusting a trade to delta neutral is not good enough. It's better to reduce gamma. In other words, buying shares of the underlying doesn't do it for me. I want to reduce negative gamma, and that means I elect to spend money on options when adjusting.
Another way to reduce negative gamma is to trade options that have less gamma. Front-month options come with high gamma and high theta. In other words, more risk and more reward. To lower negative gamma, consider avoiding front-month options.
That brings us back to the question: When is gamma too high?
'High" gamma does not necessarily have a 'number' associated with it. Look at it this way. You have a (premium selling) trade and it goes
against you. You adjust delta back towards zero.
Assume you are going to adjust again when the stock moves another X% or Y
You will lose money on the move and be short more delta since the last adjustment.
If you are short too many delta and if the loss is
larger than you are willing to accept between adjustments, then gamma is HIGH.
It means delta changed by too much.
Choices: Adjust sooner or reduce negative gamma.
Thus, 'high' is a relative term. Your comfort zone tells you when gamma is too high. I cannot supply a number.
If you are trading a $5 stock, then the $4 call undergoes a huge delta change when he stock moves from 4 to 5. Gamma is high. If it's a $100 stock, delta does not change much when the stock moves from $99 to $100 and gamma is much smaller. Thus, gamma is not the only risk factor to be considered.
Don, there's no method for using negative gamma to your advantage. However, if you manage the position such that losses incurred due to adjustments are less than the gains from positive time decay, then negative gamma is not going to hurt.