Does anybody have any comments/insights (or research papers) on managing a short gamma position iin equity volatility? What is the optimal hedging strategy?

I'm a bit rusty on this - its been a few years or more but being short gamma is akin to being short volatility which in equity markets can be risky. Most traders prefer to trade long gamma but where they are short, for example by selling straddles, they will try to buy gamma on outlying strikes to protect against discrete moves. Basically, if you are short gamma, then the only way to hedge is to buy some in elsewhere.

sorry, i dont think you understood my post...i am short vol, and i am trying to minimize my rehedging frequency....i.e. i dont want to keep selling my hedge low and buying it back high...i would like to know the best way to manage my (for example) short call/ long stock position...i know i should rehedge less in a range bound mkt and rehedge often in a trending mkt...is there any other advice out there...?

QuoteOriginally posted by: buylo...i am short vol, and i am trying to minimize my rehedging frequency....i.e. i dont want to keep selling my hedge low and buying it back high...i would like to know the best way to manage my (for example) short call/ long stock position...Why do you want to minimize your rehedging frequency? Do you believe that rebalancing more often costs you money? If you rebalance every five minutes, you start to look like a textbook Black-Scholes hedge. Isn't that what you want? In other words, you sold an option because it was too expensive, right? In the B-S world, your hedge trading is an (oppsite) replication of this strategy. So is your replication strategy going to expose your short call as being not overpriced? Why? Quotei know i should rehedge less in a range bound mkt and rehedge often in a trending mkt...is there any other advice out there...?Don't believe the hype. The only way to find out if the market is rangebound or trending is after the fact. Who told you to rehedge less in such and such a market? Why do you believe them? Is this short option priced too high, just right, or too cheap? Your hedging enforces this belief system.

no...i am going to lose more money (or not make more money) if i hedge too fequently... just as i dont hedge every five minutes with my long gamma positions...you have to run your delta a bit..as for my short gamma position, i dont want to get whipsawed by the market and pay "realize" more than i sold my call for...to answer your question, rebalancing too often (short or long) costs too much...and i am not talking about transaction costs ( i pay virtually nothing to trade stock)...

QuoteOriginally posted by: buylo...i am going to lose more money (or not make more money) if i hedge too fequently... just as i dont hedge every five minutes with my long gamma positions...you have to run your delta a bit..as for my short gamma position, i dont want to get whipsawed by the market and pay "realize" more than i sold my call for...So there's a difference between replicating the long option versus replicating the short one?Quoteto answer your question, rebalancing too often (short or long) costs too much...and i am not talking about transaction costs ( i pay virtually nothing to trade stock)... So it "costs" more to hedge short gamma than hedging long gamma? Hopefully you charged enough for this risk preference. Why did your counterparty take your offer? Maybe the matched price - at which you traded the option - affords him more room for hedging "costs?"

QuoteOriginally posted by: buylo...i am going to lose more money (or not make more money) if i hedge too fequently... Maybe you should fire up Excel, and do some simulations. You know, give yourself some time to think your way through it a bit...

i am not sure if your comments are hostile or not...think of it this way....do you believe that you can maximize volatility by choosing an optimal rehedging strategy? yes? well, you can minimize volatility by choosing an optimal rehedging strategy...hence the difference...

buylo-the answer to your question is entirely time series dependent. if realized is indeed lower than implied - you will make money on a continuous rehedge (ignoring your almost zero transaction costs). you can only go as far as to say "what would have been the optimal rehedging strategy with this type of time series. you are correct, in a trending market you want to rehedge as often as possible since you want to do the opposite of a long gamma position where you want to catch the reversals. by definition though, if you have a nicely trending market your realized volatility goes down... hence you will make money with your hedge and your decay. even if it reverses at the top and then keeps trending down again - you are still fine. the problem is when you have zigzag moves above and below your neutral delta. hence, the answer, in a trending market you will want to rehedge as often as possible, in a stable market - you don't have to and in a mean reverting up and down market as little as possible if you can help it. but who's to say what's what when it happens. hence the time series analysis to increase your probability of calling it.... hope this all makes sense. t

QuoteOriginally posted by: buylo i am not sure if your comments are hostile or not... No - don't get the wrong idea. If I wanted to be petulant, I would be. My comments are meant to inspire honest and healthy critical thinking.Quote...think of it this way....do you believe that you can maximize volatility by choosing an optimal rehedging strategy? yes? No, I don't. I don't think that by taking thought I can increase or decrease the slope or landscape of local volatility one cubit. I do believe I can set up my position to take advantage if vol does what I want it to. But my thoughts, wishes and hopes are not going to change the dynamic of the underlying. You're going to know exactly what would have worked best right after it happens. "Oh look! A trending market! If only I had let my deltas run..."

buylo, I am not sure you exactly know what you want to do. Are you trying to hedge a position with a huge liquidity constraint ? If not, just hedge your option on the close, or, on the open, or more frequently. It doesn't really matter, you just have to be consistent with the way you looked at the trade when you took the position (so basically, hedge with the volatility you looked at). Otherwise, you are more betting on the intraday dynamic of the spot but it is a totally different job. Of course, nearly every trader will do it occasionaly, but this is really a bet. There is no strategy in that (simply because, from an option perspective, the expected value on one trade on the cash market is zero, with zero rates, divs, etc).

I undersootd buylo wants to hedge a short position on volatility gamma (one word).Is that correct? What's your position?Anyway, if this is the case, the point is that trading vol (via var swaps, options or whatever) has much highertransaction costs than trading stock. Hence, there is a substrantial impact of transaction costs. Buylo: did you consider using "raised volofvol" alongside the ideas of Zakamouline ?

QuoteOriginally posted by: PaperCutQuoteOriginally posted by: buylo i am not sure if your comments are hostile or not... No - don't get the wrong idea. If I wanted to be petulant, I would be. My comments are meant to inspire honest and healthy critical thinking.Quote...think of it this way....do you believe that you can maximize volatility by choosing an optimal rehedging strategy? yes? No, I don't. I don't think that by taking thought I can increase or decrease the slope or landscape of local volatility one cubit. I do believe I can set up my position to take advantage if vol does what I want it to. But my thoughts, wishes and hopes are not going to change the dynamic of the underlying. You're going to know exactly what would have worked best right after it happens. "Oh look! A trending market! If only I had let my deltas run..."Hahahahahahaha, that was a great comment. Ohhhhh ahhhhh what a trending market. I should have bought a'at that point' and gone surfing or begging and 'come back to sell at this point'. whoaaaaahhhaa, i cann't stop laughing papercut. Great comment.NOW, Mr. Buy-Low ,that is your nick. So stick to equity only. Buy low and try to sell high. Cheers.Lesson number 1- When seniors are trying to tell you something, listen to them. Don't assume that we are obliged to tell you the 'truth'.cheersP.S. - Oh,yes, I am being a little sarcastic. B'z, I have been a good student to the 'seniors'(by seniors, I meant,not by age,but by the number of years in the field). In general, I have been well-behaved in the learning sphere.

hi,.. buylo, i understand wht u wanto to do.. my answer wud b vry subjective n i dont think evryby wud b comfortable doing it..wht u can do is, set a certain 'band' around the underlying's price in which u will take limited action.. now the question is wht factors do u conider while doing this band thing.. technical charts of the stock can help,. add to it a lot of subjectivity and intuition!i wud say, stick to the 'reliously delta hedging' principle at far frm the expiry, start of the series, wen the gamma of the position is comparatively less negative...As the xpiry is nearing and the gamma of the position is increasing, start leaving a band for the underlying price and keep increasing the band..THIS strategy is not foolproof and does not ensure tht u end up not loosing money, u may actually loose more money if the stock decides to whipsaw AROUND THE BAND... nevertheless, U R TAKING a CHANCE... my view is tht there is less likelyhood of the stock whipsawing around a BAND than of it whipsawing around a PRICE...I hav tried this out of experiment n it has worked for me... ---------------------------------------------------------------------------------------------------------------------I know I am SHORT on LUCK, so to HEDGE myself, I go LONG on HOPE..---------------------------------------------------------------------------------------------------------------------

Not sure if it is what you need, but Taleb's "Dynamic Hedging" has some advice about that, in particular end of chapter 4.