Introduction

Gamma scalping is a sophisticated trading technique used by options traders to dynamically hedge their gamma exposures in response to underlying asset volatility. It's essential to understand the concepts of gamma and delta, as well as synthetic positions and delta-neutral strategies, to effectively implement gamma scalping. In this article, we'll delve into these concepts and provide a step-by-step guide to gamma scalping, along with examples.

Understanding Gamma and Delta

Gamma is a measure of the rate of change of an option's delta. Delta serves as a barometer for what the equivalent position would be in the underlying asset, such as a perpetual swap (perp). To scalp gamma, traders need to understand and monitor the option's delta.

Synthetic Positions

Options traders can replicate the payoff functions of other positions using combinations of underlying assets, delta-one instruments (e.g., perps), calls, and puts. Various synthetic positions can be crafted using a combination of options and perp.

Examples

• Long Call = Long Put + Long Perp

• Short Call = Short Put + Short Perp

• Long Put = Long Call + Short Perp

• Short Put = Short Call + Long Perp

• Long Perp = Long Call + Short Put

• Short Perp = Short Call + Long Put

A trader seeking capital-efficient long exposure to Ethereum (ETH) can achieve synthetic long exposure by purchasing an ETH call and selling an ETH put.

Delta-Neutral Strategies and Vega

Options traders can trade volatility without directional risk using long vega or short, delta-neutral strategies. Long vega strategies benefit from expanding implied volatility (IV), while short vega strategies benefit from contracting IV. The discrepancy between market expectations (IV) and reality (RV) is referred to as the Volatility Risk Premium (VRP).

Popular delta-neutral strategies include straddles, strangles, and calendar spreads. Traders often choose long vega, delta-neutral strategies when IV is trading at a discount relative to realized volatility (RV). However, these positions have negative theta, meaning their time value continuously erodes as expiry approaches. To offset this decay, traders can rebalance their positions to hedge their deltas while potentially booking a profit. This process is called gamma scalping.

Gamma Scalping in Practice

Consider a long straddle with a zero delta at the outset of the trade. The 0.50 delta of the long call is offset by the -0.50 delta of the long put. However, this changes with underlying price action, necessitating gamma scalping.

Example

Suppose SOL trades at $20, and you open an at-the-money (ATM) long straddle for $5.00, paying $2.50 for the long call and $2.50 for the long put. If SOL rises to $22, your straddle is worth $5.50, but you're no longer delta-neutral, with a net delta of 0.4.

In this scenario, a gamma scalper might short the equivalent quantity of perps needed to rebalance their net delta back to zero. If SOL dips back to $20, the trader can close their short perps position at a profit, logging a successful gamma scalp . If the price of SOL had instead decreased, the trader could have executed a gamma scalp by longing a perp to neutralize negative delta.

Gamma and Theta: A Balancing Act

To profitably gamma scalp an options position on any given day, the proceeds from each day's scalp must exceed the day's theta costs. Gamma scalping is essentially a tug-of-war between gamma and theta.

The primary utility of gamma scalping for traders is to offset the theta costs associated with long-volatility, delta-neutral strategies. For this reason, it's crucial to diligently plan your exits and not get greedy.

Knowing When to Leave the Party

When IV rises to your target level, it's time to close your position at a profit. Keep in mind that theta costs only increase as expiries draw closer. Therefore, timely exits are critical to maximizing profitability while gamma scalping.

Conclusion

Gamma scalping is a valuable technique for options traders to hedge their gamma exposures, offset theta costs, and pad their books. Understanding the concepts of gamma, delta, synthetic positions, and delta-neutral strategies is invaluable for navigating derivatives markets with tact. By diligently monitoring and adjusting your positions, you can reduce your downside risk while simultaneously booking additional profits. Ready to try your hand at gamma scalping? Dynamically hedge your options positions with perps on Zeta.