About Option Trading – Option Trading Strategies Video 32 part 1

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Hello, tradeologists. I want to introduce you to a very powerful technique, that has been a staple trading technique of professional floor traders on exchanges across the world. This is called Gamma Scalping. I’ve heard people call it Gamma trading. The idea of day trading, without the risk normally associated with day trading, is what this particular strategy is all about.

First, I want to emphasize two things. First, we’re going to be talking about the sale of stock and the purchase of stock, sometimes in large quantities. I don’t want you to be concerned about that just yet. I think it’s important for you to understand how the position fits together, and how the strategy works out to make a profit for you.

This is a potentially difficult concept to grasp, but as we go along over the next 20 days – the 20 videos that we are putting together are actually over a 20-day period. You’ll be able to understand how Gamma Scalping is such an extremely powerful method for trading just about any type of stock or market.

The idea behind Gamma Scalping is really to take advantage of and lock in profits, as prices fluctuate. It is designed to capture as many of those movements as possible, as the stock goes up and down. Really, the idea here is the opposite of what we’re doing with positive Theta trades. With positive Theta trades, we are trying to capture as much Theta as we possibly can. We’re trying to capture that time decay of the options that we have sold over time, to expiration.

In most cases, you only want to be able to put these positions on when you are Gamma positive. As you know, when you are Gamma positive, your Theta will be negative. If you are Theta positive, your Gamma will be negative. If you are Theta negative, your Gamma will be positive.

These are trades that you’re going to do only when Gamma is positive. In other words, you want Gamma to affect Delta. Gamma, remember, is the rate of change of the Delta. You can consider this type of strategy as a Delta-neutral trading strategy, because what we’re trying to do is continuously keep our Deltas in a neutral position.

The very core of this trading strategy is the straddle, or strangle, position. Let’s go back to our Trade tab for a second. We’re going to put in the IWM, which is the Russell 2000 index fund. We want to take the nearest month’s options. We have August up. We have September, November, January, February, and January of 10.

If you recall from your study of the Greeks, Gamma becomes more sensitive, and it becomes larger, the closer you get to the money, and also the closer you get to expiration. What we want to happen is to have Gamma be as much as possible in these trades, affecting the Delta of our position.

The basic strategy is to purchase a straddle on any stock position on ETF. The criteria to make this work is basically, you want a stock or an ETF that is going to move a lot. In our other trades, in positive Theta trades, we don’t want the stock to move. We want it to stay in one place, in order to capture the positive Theta, the time decay, of that option.

In this case, what we want to be able to do is have the stock move as much as possible, so that we can ideally trade the stock, as it changes the Delta of our straddle position. That is an important distinction, because we want it to move as much as possible.

If possible, we would like to make 2, 3, 4, or more trades a day. That’s not always possible. We would like to make at least 1 or 2 trades a day. The reason for that is, since we are buying a straddle, we have time decay, negative Theta, working against us.

Let me just show you an example. As you recall, if I bring up my SPY position here, Theta is positive on this position. That is the rate of decay for this position, on a daily basis.

We don’t want the price to move too much in this position. We want it to be relatively stable, so that we can gather as much profit potential as possible. Our white line is our current profit and loss. Our green line is the expiration date. As time moves forward – I’ll draw your attention down to this date clock down here. If the price remains stable – right now, it’s at $143.25 on the SPY – and if we toggle the date ahead, you’ll notice that the white line is moving up. Our Theta is increasing, the closer that we get to our expiration.

We are in the August of 08 expiration date. As we get closer to our expiration date, our Theta will increase. The amount of profit that we generate based on the theta decay increases. As long as the price doesn’t move too much, we continue to generate a profit from the position, until we get to expiration. That is where we have captured the maximum profit in this position.

Contrast that with buying a straddle. Let’s buy a straddle on the IWM. I’m going to chose the 71 straddle. It’s currently priced at $3.62, as a debit. We can play around with different strike prices. We can go from 71 to 72, to 73. We can go down to 70. We want the straddle that is the cheapest. In other words, we don’t want to pay too much for our straddle.

Now, with this position, with this strategy, we really have to have more than one or two contracts. I would suggest that you need a minimum of 10 contracts to be truly effective with this strategy. You’re buying a straddle with at least a minimum of 10 contracts. The reason for that will become apparent, as we proceed.

Let’s go ahead and take this over to our Analyze tab for a second.

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