Last update: July 2021

Gamma Scalping Series

1. Part 1: Intro to Gamma Scalping
2. Part 2: This is How you Scalp Gamma
3. Part 3: Timing Your Scalps

Today kicks off a multipart series on gamma scalping. It’s a strategy that I’ve taken a renewed interest in due to recent changes in trading costs. And, one of the best ways to chronicle my discoveries is to share the lessons learned with others.

Let’s begin.

Free Trading

Commissions for stock trades was recently slashed to zero. And while stock traders rejoiced, options gunslingers like me viewed the news with indifference. The shift, though seismic for equity speculators, barely moved the needle for those who already had a competitive commission rate for options trading. I saw my cost drop 5 to 10 cents per contract. It was great, but not life-changing.

It did make me rethink a strategy I was introduced to years ago but never really used. Back then, there were two hurdles to properly executing this particular system. One was the high cost of stock commission, and the other was the higher capital requirements.

Fortunately, both hurdles have been removed. The first was taken care of when the veterans of the brokerage industry finally decided to fight back against the mounting competition from the likes of Robinhood and other up-and-coming free trading platforms.

My account’s growth has overcome the second hurdle of high capital costs. I now have sufficient funds to engage in gamma scalping without worry that it will overly tax my available capital.

Strangles, Short Strangles

The strategy we will be using the gamma scalping technique with is a short strangle. If you need an in-depth exploration, check out the video overview in our Tackle Trading Playbook. Strangles are the simplest way to sell premium because they’re delta neutral and only involve two legs. The structure involves selling an OTM call and OTM put in the same expiration month.

Short strangles boast the following Options Greeks:

• Delta Neutral – This means it starts with a delta close to zero. We aren’t profiting from a directional move. Instead, we’re relying on theta and vega to drive the gains.
• Theta Positive – We are profiting from time decay. The passage of time helps us.
• Vega Negative – We are short volatility which means we profit as implied volatility falls. Another way to think of it is we are betting the market moves less than expected, or that options are overpriced.

Suppose you have a $100 stock. A short strangle might involve selling the Jan $105 call for $2 and selling the Jan $95 put for $2. You’ve entered a Jan $95/$105 strangle for a $4 credit.

The Delta Generator

If you wanted, you could keep things simple. Sell the strangle, preset your exits if the stock rises or falls too far, and then let it ride.

Or, you could hedge along the way by rolling the untested side to pick up more credit or adding extra naked puts when too bullish or naked calls when too bearish.

Or, you could gamma scalp with stock. To fully understand this, a brief review is in order.

An options delta is not fixed, it’s variable. That means the delta of a call or put will change as the strike price moves ITM or OTM. Because of this, short strangles don’t remain delta neutral throughout the trade. A rising market makes the strangle become delta negative. A falling market makes the strangle become delta positive.

The reason is gamma. It is the force that generates more deltas as the market moves.

And the potential problem with your strangle racking up deltas is it disrupts what you were trying to accomplish in the first place. You were trying to create a position that profited from time decay or the overpricing of options. But as the delta grows, your success becomes more dependent on the stock price moving in the right direction.

And that’s a bummer – because it’s easier to rely on time passing to produce your gains than the stock price behaving itself.

So how do you gamma scalp? You buy and sell shares of stock incrementally throughout the trade to keep the delta close to neutral. The benefit is you keep your directional exposure minimal so theta and vega can maintain their control as the primary drivers of the trade.

Next week I’ll show you some examples.

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