Gamma Acceleration – Key Points About Selling Options Part 9
Gamma Acceleration – Key Points About Selling Options (Part 9)
This is where I’ll get into a bit on Gamma and Vega, when you sell options you’re selling Gamma. First of what is Gamma? Gamma is the acceleration of your Delta. Delta’s change as the stock moves and a question is what direction are they changing? Are they changing in my favor or are they changing against me? And when you buy options you want that 50 Delta to become a 60 to become a 70 to become an 80. And if it does you are making money, you’re positive Gamma. If it goes down 40, 30, 20, if it’s going in the other direction, it it’s going in another fashion your p&l on that trade is going in a negative fashion. So, it’s a positive correlation or positive Gamma. When you sell options it is the opposite. If we sell a 50 Delta call option and it moves in a positive way up to 60, 70, 80 that’s working against us. So, selling options has negative Gamma.
If you understand Gamma a bit, what that means is you don’t want stock movement now the Greeks and can sometimes be a bit difficult to grasp, and totally understand. But by and large if you’re doing a thorough analysis and a common sense evaluation of premium in relation to pricing factors, you’re incorporating a Greek analysis and you might be thinking about Gamma if you didn’t even know it. But the last thing I’ll say about Gamma is it is greatest ‘at the money’ in near-term just like Theta is and that makes sense. How fast is the Delta going to change if the stock price moves. Well, there’s one minute till expiration and the stock is at my strike price or it’s ‘at the money’ and the stocks moving up and down above the strike below the strike that Delta is going to be flipping around wildly from fifty to a hundred from 50 to 0. That’s a massive change in your Delta and that means Gamma is at its greatest. Much further out in time, a one-year option is going to have rather subtle changes in its Delta. So, Gamma is going to be smaller as you go out further in time and away from ‘at the money’. It’s logical.
What about Vega? Vega is our exposure here as well. We sold volatility, we don’t want it to go higher, that would work against us as options sellers. So, what’s the exposure there? Vega is greatest similar to the others ‘at the money’, but Vega is actually greatest long-term. Vega is the expectation for how much the option premium will change in value for a 1% move in implied volatility levels. That is greatest further out in time. If implied volatilities from 31 to 32 that’s going to have a greater monetary effect on longer term options, in our case being the seller, a negative effect on longer-term options. So, there’s Theta exposure and there’s Gamma that you have to be concerned about. It’s rather simple to understand, what the Gamma is all about with respect to not wanting a stock to move, and then there’s implied volatility exposure. And now you have a sense for where those are the greatest and where they are the least. Now, I want to shift gears a bit from all of that. That was heavy into selling calls, selling puts and some Greeks and some concepts on premium.