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Gamma-Theta-Vol triangle
The entire concept of volatility trading can be simplified into a triangular relationship between Vol-Gamma-Theta.
Although it might seems oversimplifying a rather complex dynamic of option trading, your realized pnl will be determined by that triangle
The entire concept of volatility trading can be simplified into a triangular relationship between Vol-Gamma-Theta.
Although it might seems oversimplifying a rather complex dynamic of option trading, your realized pnl will be determined by that triangle
Let's understand how this three-way relation affects your option trading pnl...
We know that volatility determines the cost of the option, so to have a profitable option strategy we first need to be on the right side of the trade (buying cheap vol, and selling rich vol), but
We know that volatility determines the cost of the option, so to have a profitable option strategy we first need to be on the right side of the trade (buying cheap vol, and selling rich vol), but
once we traded the option we enter the gamma-theta phase of running the day-to-day risk of our strategy...
Our premiums (paid or received) are given at inception, and we can think of the option premium as a series of T interval straddle breakeven, so to be profitable we need
Our premiums (paid or received) are given at inception, and we can think of the option premium as a series of T interval straddle breakeven, so to be profitable we need
either to realize above (if we are long gamma) or below (if we are short gamma).
Our Gamma is also affected by the vol, as it has inverse relation with the level of vol (the higher the vol, the lower our gamma and vice versa). If we are buying high vol, our dDelta/dSpot will be
Our Gamma is also affected by the vol, as it has inverse relation with the level of vol (the higher the vol, the lower our gamma and vice versa). If we are buying high vol, our dDelta/dSpot will be
low, so if we are long gamma we will either need meaningful move to accumulate delta, or hedge relatively small delta at a fixed% move.
This is where the gamma-theta relation comes to play... we know our daily theta, and we know our gamma, so at the end of the day our profit
This is where the gamma-theta relation comes to play... we know our daily theta, and we know our gamma, so at the end of the day our profit
is determined by the way we monetize our delta hedging (which is how we realize the volatility).
This triangle also dominates volatility cycles. As investors sell vol to lower volatility levels, their -ive gamma increases, they will have less delta-tolerance and cause
This triangle also dominates volatility cycles. As investors sell vol to lower volatility levels, their -ive gamma increases, they will have less delta-tolerance and cause
a cascading effect of higher realized volatility -> higher implied volatility (I know there is more to that, vanna/charm/dealer GEX, but for the sake of the argument I'm making that simple)
That is the reason, imo, that vol short squeeze is much more powerful than a 'normal'
That is the reason, imo, that vol short squeeze is much more powerful than a 'normal'
one. The leverage that our gamma provides us, causes asymmetric pnl profile.
Now, I'm not trying to advocate either long, nor short gamma, but to trade volatility profitably and efficiently we need to be aware of this dynamic
Now, I'm not trying to advocate either long, nor short gamma, but to trade volatility profitably and efficiently we need to be aware of this dynamic
