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Let’s take a look and see how much that sells for. The straddle is about $2, for the August expiration. How do we actually determine whether that is a good price or a bad price?
One thing that we want to do at all times is take a look at the implied volatility. It’s at 42%. Is that high or low? It could be high, it could be low. We really don’t know. If we take a look at the stock itself, we notice that it has been in a downtrend. However, it has traded sideways for quite a while, which has helped reduce the volatility in the issue.
The one thing that we want to do for sure is go over to our Trade tab. This is how we will be able to determine whether or not this is a good issue to trade. We’re going to use 10 contracts in this example, at $2 a straddle.
As you can see, if we purchase the at the money straddle, which is the 26 August expiration straddle, we have a Delta starting out at about 29 or 30 positive Deltas. That’s fine. That’s not very much. That’s actually a pretty good number. It’s relatively Delta-neutral.
The one thing that we want to do, though, is be a little bit more scientific in our selection of the stock. What we want to do is take a look at the probability analysis tab in our Think or Swim platform.
What that does is give us an idea of the stock price volatility, which is 39%, over the next 20 days. In other words, what we want to do is take a look at what the volatility would determine is the high or low of the stock price, before the August expiration. We are trading the August expiration.
The greater the range that we can capture profits in, the more successful we are going to be in Gamma Scalping this issue. We can also determine from this analysis chart what effect volatility is going to have, whether increasing or decreasing, on our straddle position.
Remember that we’re fighting against Theta. The one thing that we really want to have is a very large range in which the stock price can move, in order to profit from the fluctuations. All the time, we need to consider the fact that we need to make more than the amount that we are losing, based on Theta decay.
In this particular issue, the Theta, at the current price, is $47.69. For each day that goes on without the price moving, we will lose $47.69. If we take the Date tab here, and simply increase the date, you can see that Theta, at $40.85, increases each day, as time passes. It decreases our profitability by the exact same amount.
Each day that passes, Theta is recalculated. As long as the price does not move, we can lose that amount in Theta for each day that passes. Let’s go back to our current date. The same thing with volatility. Volatility is another problem with Gamma Scalping. It’s certainly something that we want to take a look at.
With Vega at 47.57, it means that we can adjust volatility in our Analysis tab. If we were to decrease the volatility, you can see that by 1%, we will decrease the amount that we make on this position, by exactly $47.57, by each percentage of volatility.
If volatility were to increase, we would make that amount, in additional profits on our straddle. An additional 1% volatility would increase our profitability by $47.64. As we do our analysis of different issues that we’re considering doing our Gamma Scalping on, we need to carefully consider the Vega position.
That is one of the most important Greeks, as far as Gamma Scalping go. As volatility increases, we make money. If volatility decreases, we lose money. It just makes sense that we don’t want to buy issues that are at the high range of their historical volatilities. We want to buy them in the low-to-mid section of their volatilities.
The way we can determine that is simply to go over to their profit charts, and determine exactly where the volatility of this particular issue is. If we go over here, and put in JNPR, I have already called up historical volatility. I’ll do another study here. Just to show you how this is set up, I’ll go into my studies, go to “Apply studies,” and in the left-hand box here, all you have to do is scroll down until you get to historic volatility.
Just take that, and drag and drop it right into your window. It will automatically call up the historical volatility. Now, would you say that Juniper Networks is in the lower end of its historical volatility? Would you say that it’s in the high end of its historic volatility? Or is it in the middle?
It looks like it’s kind of in the middle of the upper range, upper end, of its historical volatility. We already showed, in the Analysis tab, that if historical volatility decreases, it comes down from these levels. If it goes down from 1% from its current levels, then we actually lose money on the position.
Because we are long calls and long puts, we are going to have a positive Vega on this position. Let’s go back to the profit chart for a second. Now, considering that this is at the higher end of the range, over the past five years – this is a five-year daily chart – we want to take a look at the long-term view of the historical volatility.
If the volatility is at the high end of the range, there is a possibility that it could go up a little bit higher. We’re more likely to come down from this level. If we take a look at the historical volatility, we can see that it has decreased, each time it has gotten close to this level.
The probability is that it will decrease, rather than increase. That will hurt our position.
There are several factors besides volatility that help to make this a good candidate for our Gamma Scalping position. That is the fact of the price of the actual at the money straddle itself, the range at which it can move, the current stock price, and the historical volatility, as we mentioned. If we put those all together, we can come up with a fairly objective analysis of each of the issues that we’re considering.
As I mentioned, you can get your list from any place that you like. You can have your own watch list set up. You can go into the TOS tab here for Index Details, and you can take a look at any of the ETFs, the Dow – you can pretty much select any issue that you want, as long as it’s liquid. As long as it’s trading at least a million shares a day. I would probably say a little bit closer to 2.5 to 5 million shares a day. You’re probably better off on the issues that trade a larger number of shares, only because you will have a better bid-ask spread on the options themselves, as well as more liquidity in the stock.
You can pick any issue that you want. You can go into a newspaper like the Wall Street Journal, the Investors’ Business Daily, and you can select stocks that you see that are in the news. Then, once you get a short list together, you can take a look at it, and plug it into a spreadsheet that I prepared for you. It is proprietary to Tradeology, and it’s for your use only.
Let me take a look and see exactly what this looks like. Basically, all we have to do is take a look at certain variables in the stock we’re considering doing the Gamma Scalping with. We’re going to be taking a look at several issues. I’m going to be adding issues down at the bottom here, so that you can get an idea of exactly how to enter this information yourself.
You will have a copy of this spreadsheet in the folder with the video.