What’s not to love about the gamma scalp?
Turns out, plenty.
Gamma scalping is a semi-complex strategy that continuously hedges the deltas of a
long straddle using—in its simplest form—
stock. As a stock price moves up and down,
the deltas of a straddle can go from positive
to negative. The stock trades become (
hopefully) profitable scalps, and they offset the
losses from negative time decay.
But let’s look at the numbers. Say the
stock is $100, and you buy the 100 strike
put and 100 call. Assume the delta of that
straddle is close to zero, while gamma is
0.80. If the stock price goes up $1, the delta
theoretically increases by 80. If the stock
price goes down $1, the delta theoretically
drops by 80.
If the stock goes from $100 to $101, the
delta of the 100 straddle goes from zero
to 80. The gamma scalper sells short 80
shares of stock, and the position (straddle
plus short stock) goes back to zero. Say the
stock drops from $101 back to $100, and the
position’s delta goes from zero to -80. The
gamma scalper buys 80 shares of stock to
get the position delta back to
zero. The gamma scalper is
left with the long 100 strad-
dle (the original position).
She made $80 selling stock
at $101 and buying it back at
$100. If the long 100 straddle
had theta (time decay) of - 20 per day, the $80
scalp more than offset it. The gamma scalper
“defended” the long straddle with the scalps,
and was able to hold that straddle to wait
for the big move. That’s how it’s supposed
to work, and what makes gamma scalping
But there are problems. First, commission
costs can get high with so many stock trades.
Second, if the stock price doesn’t change,
and the long gamma doesn’t “manufacture”
any deltas to scalp, the time decay still eats
away at the straddle’s value. Third, the long
straddle has long vega. And if implied vol
drops, it can take the straddle’s value down,
all else being equal. That means the stock
scalps have to offset theta and vega risks.
Finally, successful gamma scalping means
you’re buying and selling stock at relative
tops and bottoms. If the stock went from
$100 to $101 and the gamma scalper sold
80 shares, who’s to say it wouldn’t continue
higher in the “big move” that would make
the original straddle position profitable? You
don’t want any short stock in that case.
For gamma scalping to be profitable, too
many things have to go just right. Sometimes
large institutions do a version of gamma
scalping across all the firm’s positions. But
that’s a different case.
Consider a long iron condor. It’s an al-
ternative to gamma scalping around a long
straddle if you think a stock might have a big
move up or down. A long iron condor might
be short the 98 strike put, long the 99 strike
put, long the 101 strike call, and short the
102 strike call. It’s a long put vertical plus
a long call vertical, and you pay a debit for
it—which is also the strategy’s max loss (not
including commissions). That max profit oc-
curs if the stock is below $98 or above $102
at expiration, and the max loss occurs if the
stock is between $99 and $101 at expiration,
with breakeven points at $99 (minus the
debit paid) and $101 (plus the debit paid).
Like a long straddle, the long iron condor is
profitable if the stock has a big move up or
down, yet loses if it doesn’t.
There are also other alternatives to the
long iron condor. And although they also
have commissions, they may be less than
with gamma scalping. Also, the long iron
condor and its cousins may not require
constant trade adjustments, as with gamma
scalping, and might carry less risk.
SO IT MAKES SENSE TO SEND THE snake-oil salesmen packing. Always bring a healthy
dose of skepticism to “can’t lose” trading
strategies. Consider the basic premise and
leverage a smarter strategy.
Thomas Preston is not a representative of
TD Ameritrade, Inc. The material, views, and
opinions expressed in this article are solely those
of the author and may not be reflective of those
held by TD Ameritrade, Inc.
For more on the risks of trading and trading
options, see page 37, #1– 2.
FIGURE 1: The lure of cheap OTM options. On the Trade page of your thinkorswim® platform, bring up
the option chain. Although the options may be cheap, the probability of the option being in the money at
expiration could be very low. Source: thinkorswim® from TD Ameritrade. For illustrative purposes only.
YOUR WAY TO
ABOUT A STRATEGY
MONEY WHEN A
STOCK GOES UP
OR DOWN, AND
YOU DON’T LOSE
ON TIME DECAY?