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VolMaster
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Re: What is Gamma scalping, really?

December 19th, 2017, 2:33 pm

I've been running prop FX volatility for about 7-years and I can give you a handful of days where i hit the jackpot or lost a small fortune... 
 
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outrun
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Joined: January 1st, 1970, 12:00 am

Re: What is Gamma scalping, really?

December 19th, 2017, 4:14 pm

I've been running prop FX volatility for about 7-years and I can give you a handful of days where i hit the jackpot or lost a small fortune... 
Hahaha, I bet you can in 7 years,! I've seen quite some prop traders who didn't make it past the first 2 years, after 7 years you must know what you are doing and how to do it.
That's actually interesting, perhaps it's also not out of the ordinary to experience extremes (both ways), every distribution has tails no?
 
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lovenatalya
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Re: What is Gamma scalping, really?

December 19th, 2017, 8:01 pm

Nice war stories, guys. Thanks. Now that it is clear what the so-called Gamma scalping is just a variance trade, let me ask a further question. It seems there is nothing special to be done aside from delta hedging. In other words, what else do you do besides delta hedging? Suppose you hold a vanilla call, and thinks that the realized vol is going to be lower than the implied vol during the hedging period. You are expected to loose money so long as you keep holding the same amount of the call. Aside from selling off this call, what else do you do to decrease the loss?
 
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outrun
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Re: What is Gamma scalping, really?

December 19th, 2017, 9:17 pm

Interesting question. 

How should we interpet "you thinks that the realized vol is going to be lower". Is some oracle disclosing the future to you? Or is it a worry you want to eliminate? 

You can replicate an option (long or short, one you don't necessarily own) with delta hedging... which is what you do when you hedge your option (replicate the negative option you have in order to overall stabilise the P&Ls swings from the one you own).

There is no way around having to take the loss of having bough a too expensive option at too high implied. Your expected loss will come towards you as you get closed to expiration -or faster if implied adjusts to more realistic levels-. Hedging can stabilise your expected loss but you can't change the mean.
 
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lovenatalya
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Re: What is Gamma scalping, really?

December 19th, 2017, 10:09 pm

How should we interpet "you thinks that the realized vol is going to be lower". Is some oracle disclosing the future to you? Or is it a worry you want to eliminate? 
I am a little miffed by your question. Trading IS about taking a view or a conviction about the future. Not just trading, even hard science is about believing you can find some law which will hold in the future. There is no guarantee that tomorrow Einstein's theory of gravitation (general relativity) or quantum mechanics will still hold. We just believe. There is no oracle. So I am not quite sure the question is about. Now, as for the route by which my "thinking" or view come, there are many. It could be my algorithmic model (maybe you can call it the oracle), or some breaking news or just my hunch I have honed over the years, that tells me that the future vol will be lower than the present implied vol.
You can replicate an option (long or short, one you don't necessarily own) with delta hedging... which is what you do when you hedge your option.
That seems to be just what I said in my last post "It seems there is nothing special to be done aside from delta hedging. In other words, what else do you do besides delta hedging?

replicate the negative option you have in order to overall stabilise the P&Ls swings from the one you own
I think you are saying the same thing as my comment below the formula I gave for discrete hedging. Quote: "When we take expectation at time 0, the second stochastic integral disappears. In fact it disappears whatever the delta hedging we put on at the beginning. The best hedging ratio is to minimize the variance of that second integral." Your stabilization is the same as my variance minimization. Agree? 

There is no way around having to take the loss of having bough a too expensive option at too high implied. Your expected loss will come towards you as you get closed to expiration -or faster if implied adjusts to more realistic levels-. Hedging can stabilise your expected loss but you can't change the mean.
I think you are confirming my surmise "You are expected to loose money so long as you keep holding the same amount of the call." And it gels with my previous assertion under my discrete hedging P&L formula "When we take expectation at time 0, the second stochastic integral disappears. In fact it disappears whatever the hedging delta we put on at the beginning." Agree?
 
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outrun
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Re: What is Gamma scalping, really?

December 20th, 2017, 10:41 am

The question was about how right you expect to be when analysing this case. With an Oracle you're saying "I know exactly what's going to happen" and that might affect your decision making (there is no risk). I don't think it's relevant looking at the follow up comments you gave.

Other things you do (in practice) is to hedge with other options and keep all your greeks within bounds. It depends a bit on the type of trading: e.g. I was a market-maker, we were managing inventory risk, getting compensated for that risk with a random bid-ask spread.. all without forming much of a view about the future (no gambling). Hedging derivatives with other derivatives reduces IV risk factor exposure, and also some model risk.

In your equation you assume an unpredictable future, and expectation will indeed be zero.

My definition of gamma scalping is however tht somehow you can predicted correctly whether the market is going to be trending (and the consequence is that you stop delta hedging and let it run) or moving sideways inside a band (and you sell at the top of the band, buy at the low of the band).

This is slightly different  than doing this without having gamma. E.g. in the trending case, without gamma, not doing anything with give you zero P&L. If you have gamma your P&L will be 1/2 gamma dS^2
   
 
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VolMaster
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Re: What is Gamma scalping, really?

January 27th, 2018, 5:34 am

The one question which, for me, seems like the holy grail of gamma hedging is how to optimize the hedging frequency. As our terminal P&L is depended on the path of the underlying spot and the re-balancing of the delta, different frequencies would yield different terminal P&L. Essentially we need to account both for target volatility and degree of trend/mean reversion