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Intermediate Strategy: Gamma Scalping Part II

By Chris Tyler, Optionetics.com | Mon September 17, 2012 12:44PM PT

Volatility and Opportunity

In Part I of this two-part series on gamma scalping we left off immediately in front of the meat of this strategy. Today, we’ll dig into this process by illustrating a series of adjustments using extremes in the CBOE Volatility Index ($VIX). To gain a better understanding of gamma scalping, we’re going to keep it as straightforward as possible and illustrate this strategy using the SP-500 ETF (SPY) during the tumultuous period of late summer and early fall of 2011.

Relative extremes in the CBOE Volatility Index, the market’s most followed gauge of sentiment and an instrument calculated from the SP-500’s options, is going to act as our primary guide for adjustments to any accumulated deltas on the straddle discussed last week. Further, we’ll offset or flatten those deltas exclusively with both long and short stock in order to maintain simplicity. As mentioned though, the use of options as a hedge could be a strong but more complicated consideration.

During our profiled period, due to an escalating Eurozone credit crisis underlying market volatility and implieds were unusually high. In turn this meant a long premium strategy such as a straddle was pricey on a historical basis. However, readers might appreciate that richer implieds are a reflection of not only current conditions, but also investor expectations going forward. Thus, high implieds, while costing more in terms of the premium paid for a strategy like a straddle, do often enough; coincide with larger price movement in the market.

Conversely, lower premiums or implieds generally find market behavior less turbulent until there’s a surprise price shock to the market such as the Eurozone credit crisis which began in late July of 2011. Net, net, the adage “you get what you pay for” sums up the pricing of a straddle at any given time. But and as we’ll demonstrate with the VIX, rather than sit with a position like this until expiration and hope it does pan out, we’ll look to use relative extremes in the sentiment gauge to help assist in a simple program of gamma scalping.

Figure 2: CBOE Volatility Index ($VIX) with SP-500 (SPY) Overlay. This daily bar chart of the VIX and SPX line graph overlay is annotated to reflect the technical timing of delta adjustments on a SPY straddle based on relative extremes in the VIX versus its 10SMA and key testing of the 30% level.

Referring back to Part I of this article, a 10x SPY October 120 straddle acts as the opening trade for our series of gamma scalps. Looking to Figure 2 this is represented by the annotated “#1” circled in yellow. The rationale behind initiating a long straddle at this point on August 17 and roughly two weeks into the credit crisis, is the VIX’s first test of the historically, overly-fearful 30% level which has come into play following even stronger extremes in excess of 45%.

The expectation at 30% is for a reversal higher or a less-likely collapse below the key level. What we see as being less likely is for premiums to simple stay at 30% as the SP-500 is flirting with the technically important 1200 level. As the index maintains a strong inverse correlation to the VIX, we anticipate a decent-sized move away from the associated 120 strike in the SPY. But unsure of which direction, the long straddle and an opportunity to begin a gamma scalping regiment appear attractive. October was chosen as the contract had less immediate time decay risk compared to September, maintained a fair amount of gamma and overall the prospect of owning vega or volatility risk during the notoriously unstable months of September and October with the dog days of August anything but sleepy in 2011; appeared all the more attractive.

 Nuts & Bolts Adjustments


Fig 1





Net P&L

VIX Technicals








First test 30%








VIX = 15% > 10SMA








>15% vs. 10SMA








>15% vs. 10SMA








>15% vs. 10SMA








>15% vs. 10SMA

Figure 3: Risk Snapshot of SP-500 Straddle & Key Criteria. Notice the relatively stable gamma during the first month of our adjustments and its impact on the straddle’s delta as the SPY moves both away and through the strike price over this period.

As noted, our stock adjustments or scalps are primarily driven by extremes in the VIX which we’ve defined in the last column of our risk snapshot. Short-term stretches or differentials in excess of 15% relative to its 10SMA are prone to prices in the VIX working their way back towards the short-term moving average. This is due to the instrument’s mean-reverting tendency. In turn, as the SP-500 is inversely correlated, we can expect to buy stock as a hedge when the VIX is “fearfully” stretched above the 10SMA and normally anticipate selling shares when the sentiment gauge turns complacently lower and aggressively below the moving average.

Notice on Sept 9 we choose to under-hedge a short delta of -425 and buy just +300 shares of SPY. This would have resulted in stronger profits if the SPY opened lower the following session. With the 9/11 anniversary wedged between the two trading periods, this small directional lean might be better appreciated, though it failed to cooperate as we can see by the slightly costlier hedge the following Monday.


Fig 1





Net P&L

VIX Technicals








13% w/ 30% & 50SMA test








>15% vs. 10SMA








14% w/ SPX 1100 test








>15% & 30% test in VIX w/ SPX at 1200








Sub 30% at 28.25% w/ >15%








VIX @ 31.50%

Figure 4: Risk Snapshot of SP-500 Straddle & Gamma Scalping into Expiration.

In Figure 4 and a continuation of our gamma scalping, look at how the profit slides by more than $500 on 9.16. This is due to the straddle approaching its final 30 calendar days, a period prone to increasing decay, while moving back towards the 120 strike. The combination began to negatively impact profits despite the quick rally as the intrinsic value of the position shrank and extrinsic value, barring a hard spike in implieds, grows ever-smaller.

The program of continued and consistent hedging paid off shortly thereafter. The market granted a nice windfall with the SPY moving sharply below the strike. This allowed for some solid trend riding of accumulated short deltas before a short-term extreme in the VIX and test of 1100 signaled to cover with the purchase of stock.  

Moving through October expiration, the position’s net profitability dropped off somewhat during the final two adjustments. Once again, increased and even larger negative theta on the straddle’s remaining extrinsic value, less movement in shares between our adjustments and a final intrinsic value of $4.00 for a straddle which we original paid $10.25, all conspired to take some profits back.

What isn’t readily apparent from our risk snapshot is the maximum dollar risk associated with the straddle which began just north of $10.25 per spread or $10,250 was fully reversed into a small minimum gain by early October and finished with a minimum profit of $3,700. As the straddle value lost about $6.25 during the life of the position, this means our gamma scalping made nearly $10,000 in profits.


Without resorting to cherry picking price direction in the market and using cheap hindsight technical calls of little real value, we’ve shown how gamma scalping can be a viable strategy for traders without getting overly complicated. And for those committed to smiling their way to the bank using their own proprietary method of managing gamma and those attached deltas; as touched upon, there’s plenty of room for tinkering beyond the principles laid out here.   


Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site
Visit Chris Tyler’s Forum
The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual. 


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