Tag Archives | positive gamma

Buying Options


I see a lot of chatter on boards for the most part concerning short
sided (premium selling) neutral plays but don't come across nearly as much on directional
type trading. In theory, I understand because this is often considered a
"riskier" play.

I have found I have the best success trading on 4 -5 stocks (and 2
indexes) over and over again, as I seem to learn their movements and
ranges pretty well.
The stocks specifically have medium to low IV and trade pretty decently
within a range for the most part.   That helps me identify
when they are outside their top and bottom levels and probably due for a
reversal of some sort at some time.

Based on this I have been paper trading some long plays thru slightly
OTM calls or puts when stocks hit a high or low level.  This has turned out
quite well over the last few months. Much better return than my short
sided plays.

I'm going to take 10% of my capital and start placing real
funds in the game.

My question is this. I'm sure you've had much experience on the buying
. Any particular recommendations you may have on this strategy?
Better to be ATM, OTM, etc? (I'm using slightly OTM as in 1 strike away)

How many months out have you found best? (I'm going 2 months out

Any particular technical indicators or other analysis tools
you find to be helpful? (I currently am just basing when price swings
outside the normal range).

Not really sure exactly what questions I'm wanting to ask but more or
less get your "been there done that" feedback as to what has worked for
you in the past. Thanks.



Hello Jason,

You see most comments about premium selling because most traders understand that is the more profitable side over the longer term – IF, AND ONLY IF, ONE EXERCISES PRUDENT RISK MANAGEMENT.

Your 'style' is unusual.  Most traders who use technical analysis believe that when a stock is trading at a new high, it's right to buy, not get short.  Similarly, a new low is a signal
to sell. 

To your questions:

I have almost never bought options as a directional play, and I've been trading options since 1975.

I do buy options to add positive gamma to a position, but the purpose is to adjust another position – not to make a directional play.

However, I do have opinions:

1) Unless you are playing for either a very quick move or a substantial move, buying OTM options is a losing strategy

2) Is your total trading history for directional plays that 'few months' of paper trading?  I ask because when buying options you must have a proven ability to get the direction and timing right.  I note you are not so sure about timing.  'At some time' is not quite good enough for trading options.  Especially OTM options.

A few months experience is not nearly enough.  Maybe you had several good years picking stocks before you moved on to options?  But I do encourage you to go ahead with your 10% plan and see if you can make money on your idea.

Please go in with the understanding that the odds of success are very much against you – track record or no track record.  Just look at the mutual funds as one example.  They hire expensive professional traders, and those guys/gals cannot outperform the market averages.

Why do you believe you can do it?  If it were me, I'd want solid proof that I had the elusive talent to consistently get it right when picking stocks – before attempting to make money by buying OTM options.   

2) If cash is not an issue, I'd prefer to buy (one-strike) ITM options.  These don't lose much to time decay and immediately gain the major portion of the move (due to high delta).

If your plan is to use leverage and buy a 'bunch' of options, looking for a big win, then that requires you to buy options with a lower delta.  But I loathe that idea for myself.  It may work for you – if you have the talent mentioned previously.

3) I like the idea of two-month options, but to be honest, when making a forecast – and especially when buying options – being accurate on timing is essential.  That's why you should KNOW, and not ask, which option to buy based on timing of the move.

Lacking that timing instinct, you are just taking a chance, no matter which option expiration is chosen.

4) Going one step farther and being even more helpful (smile), I use zero technical indicators.  I know FOR A FACT that my stock market prognostications are not good, and I do not make directional plays.

5) I have never been 'there' and I have never done 'that.'  But I hope this reply is helpful


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Gamma, Vega and Risk Management

When trading options, holding positions with too much gamma – positive or negative – can be dangerous. It's necessary to avoid getting hurt by the two most destructive emotions for traders: fear and greed.

On Monday, Jun 28, 2010 the markets fell hard.  That 1040 SPX price level – that many believe is a vital support area – was tested.  Option prices rose sharply as is seen in the performance of VIX and RVX.

Tuesday (as I write this) the markets are slightly higher and option prices are once more coming down to earth.  I had better rephrase that.  Option prices and implied volatility are decreasing, giving up a significant portion of yesterday's gains.  In my opinion, prices are still high.  ADDENDUM: By the end of the day, the markets closed lower.  SPX broke down by trading below 1030.

When IV moves sharply higher, the trader who is not vega neutral, and that includes most of us, must demonstrate the ability to handle and manage risk.  If you are a clear thinker and make good trading decisions, your portfolio is probably in good shape.  The same can be said for most traders who prepared a trading plan in advance.  That plan is designed to save any trader (and especially the inexperienced) from panicking in a stressful situation.

Positive gamma and vega

As the markets get more volatile, and especially as markets decline, traders who own positive gamma and positive vega are well positioned to profit.  Nevertheless, that trader cannot afford to idly watch the markets as the days pass and theta takes its toll. 

Positive gamma is a delight in that it allows the trader to pick the time and place for making an adjustment.  This adjustment locks in profits and can include the sale of some options to reduce both gamma and vega, or it can be made in the form of shares of the underlying (stock or futures contracts).  It's tempting to hold the position, but a minor reversal, such as seen Tuesday morning threatens much of the profits.  Greed makes the trader hold out for larger gains.  Fear makes the trader panic and sell (what is probably) an inappropriate portion of the position.

However, a well-thought out plan, or sound risk management, allows the trader to reduce risk by moving closer to neutral in gamma, vega, and delta.  Ignoring greed, the successful trader adjusts the position – retaining some vega and gamma.

Negative gamma and vega

Iron condor traders seldom find themselves in the positive gamma/vega boat.  The only exception occurs when extra options are owned as insurance, and these extra options are in play (not too far away from being ATM).

Thus, they (we) may be floundering when the positive gamma group is sailing along smoothly in those choppy waters.

If your positions have too much negative gamma, if your short options are not too far OTM, then it's time (or past time for many conservative traders) to adjust the position.  Panicking in a sudden meltdown is unlike to produce good results.  However, ignoring problems, hoping they will disappear, represents a different type of panic decision – being too afraid to act.

If you have a trade plan in place, it's probably right to take the action as prescribed in the plan.  Lacking a plan, it's not too late to create one now.  If you are capable of making sound decisions as losses mount, then good for you.  Take advantage of that skill by taking sound steps to protect your assets.  Be aware of potential loss, your pain threshold and comfort zone boundaries.

If you lock in a loss and the market reverses, so be it.  Your goal is to pay attention to rule #1: Don't go broke.

If you are not yet in trouble on this decline, you have the luxury to plan ahead.  I'm planning to sell extra vega by doing a ratio roll down* for some RUT Aug and/or September put spreads.

* Close current short put spread and sell a larger quantity – perhaps 3 for every 2 bought – of farther OTM put spreads.  I prefer to move the strike of the short option by at least 3 strikes.  Collect a small cash credit for the trade.  I only do this when my portfolio is not already at its maximum size.  Make no mistake about this trade: it does increase ultimate risk.  it looks good because the probability of the large loss is reduced.

Example buy two 560/550 put spreads and sell three 500/510 (or perhaps 510/520) put spreads.


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Lessons of a Lifetime: My 33 Years as an Option Trader;  $10


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Delta Neutral Stock Replacement

Hi Mark,

If wanted (roughly) the same potential return of a stock with limited
risk, and the ITM option's delta is 80, would raising my position
size by about 25% do that?

To be clear, I'm thinking in terms of options' implied leverage and
their implied stop loss as an alternative to buying stock and entering a
stop loss order. So if I would have bought 1000 shares of stock, I
would be buying 10 options instead, and am wondering if buying 12 or 13
would bring the delta up to 1000, as it effects my account.

Hope that makes sense.




Yes Josh it makes sense. Owning 12 or 13 options with an 80% delta gives you almost the same 1000 long deltas.  Most stock replacement strategies replace 100 shares with a single call.  Your plan provides the obvious benefits on a rally or a big decline, but there is an added benefit (the 'implied stop loss').

So to have
'roughly' the same return (measured in dollars not in
percentages), you can substitute the calls for stock.

I'm sure you recognize that these deltas change as the stock price changes, due to positive gamma.


Every so often, on a rally, the plan should be to sell one call to reduce delta back to 1000.  Obviously, you would have only 10 calls remaining when the delta reached 99 or 100.


But it's not quite the same on the downside.  If you buy calls on a decline – to get back to 1000 delta, you will fare poorly when the stock continues to go lower.  I would not buy extra calls.

Is this a smart idea?

The negative:  you must pay for time decay. 

The positive: That time decay is your cost for reducing downside risk.  Only you know the value of that risk reduction, but it seems to be a good idea to me.

There is one HUGE advantage to using a long call option instead of a stop loss order.  With the stop, you are out on a decline.  With call options, you are still in the game if the stock suddenly reverses direction, after ticking the stop loss price.  And there is no whipsaw and no extra cost.  You bought the calls – and this is one of the benefits of owning calls in place of stock.

This advantage makes it worthwhile to pay that theta decay.  And this is truly much better than the traditional stop loss.  I'd be willing to pay a bit extra in daily decay to own this position.

Good question.


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