Why Trade Options – Option Trading Strategies Video 32 part 2

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I want to show you what happens, and what the difference is between this, and our Theta-positive trades. As you can see, the Theta is quite negative. In fact, it’s a -76. That means, for each day that you hold this particular trade, you’re going to lose $76 out of this position.

That’s not a good place to be in, really. We’ll increase the date again, and see how this position differs from the one that I just showed you with the SPY, in which we were Theta-positive.

As we increase the date, you can see that the losses if the stock does not move, increase at the rate of approximately $79. In fact, the Theta itself increases on a daily basis. If the price doesn’t move, the losses mount rather quickly.

That is the danger of buying straddles, or strangles, on any particular stock. Just a little over 10 days or so here, we’ve already lost $1405 on this straddle, which cost us $3600 in margin.

Let’s see what we can do, in order to help not only make a profit, but to counteract the decline of the option premiums in the decay that takes place before expiration. As you can see, our Gamma is 182. That’s the rate at which the Delta will change.

Even at the current position, even though we bought the at the money straddle, we currently have a Delta of -130. The idea with Gamma scalping is to constantly purchase or sell stock, not options. We want the underlying stock to bring us to a Delta-neutral position.

You’re probably feeling a little bit lost at this point. I would encourage you to keep on with this, and try to understand exactly what we’re going to be doing. The purchase and sale of stock, both buying and selling on a regular basis throughout the day, if possible, will help generate and lock in profits that we can get from the stock.

All the while, we are protected from any losses on our buying and selling activities, by our underlying straddle. The only danger in this position is having or selecting a stock, ETF, or index, that does not move for an extended period of time. As we’ve seen, if the stock stays relatively stable, we have absolutely no opportunity to buy or sell the underlying security.

That will cause Theta to create and mount a larger amount of losses on a daily basis, in our position. The goal, then, is to have the price move enough, so that we can trade the stock to offset the decay of the Theta. In fact, have it move enough that we can also generate a profit, on top of the Theta decay.

The reason this Gamma Scalping method and strategy works, is because the Deltas of the position change, as the stock moves. For example, if we were to do Gamma Scalping on the IWM, we currently have a negative Delta. In order for us to get to a Delta-neutral position, even though we have a current at the money straddle, we would have to purchase stock and order, to get to a  Delta-neutral position. That’s the goal.

In fact, we would have to purchase 130 shares of stock, in order to be at a Delta-neutral position. Let’s go back and see exactly what happens. If we purchase 100 shares of stock, we would now bring the position to a relatively neutral Delta position, by buying the stock.

What happens if the stock immediately rallies, after we purchase it? Let’s take a look. Let’s adjust our price. Let’s say it goes up at least $1. Now, we are long 195 Deltas. In order to get back to a Delta-neutral position, we would have to sell the 100 shares that we purchased, at the price that we bought it at. That was, at the time, at $70.11.

Let’s adjust this to $70.11. That, the $70.11, would generate the profit – if the current price was $71.35 of $100, or $120. The difference between the price that we bought it at is $70.11. The current price is $71.35.

The price went up, allowing us to generate a profit of $125. At that point, not only did we counteract the $78 in Theta decay, but we made a $25 profit on the position. If we can do this several times a day, you can see that the profits can be generated very quickly, as long as the stock continues to move.

Let’s take an example in which the stock declines. If our current price is $70.11, as you recall, we were -130 Deltas. We go ahead and we purchase 100 shares. Now, you might be asking yourself, “Well, if our Delta is -130, don’t we need to buy 130 shares to become Delta neutral?”

That’s true. We should buy 130 shares to become exactly Delta-neutral. However, it’s more cost effective to buy shares in round lots of 100. It’s also easier to be filled.

We’re going to go ahead and continue to use 100 shares, or 200 shares, or 300 shares, or as many as we need, in order to become Delta-neutral. Now, we’ve purchased our 100 shares, to get relatively close to Delta-neutral.

If we purchased 200 shares, that would make us slightly positive Delta. Now, if you believe that there’s an imminent chance of the stock moving up, it won’t hurt you to be a little bit positive Delta. You can use positive Delta as a trading mechanism, or as a signal, to help you profit even more, if you believe the stock is going to move up.

Of course, if it moves down, that’s a different story. You can still be within 50 or 60 points of Delta, and still be Delta-neutral. We’re simply going to buy 100 shares of stock, at $70.11, which is the current price.

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