Long and Short Gamma

One primary law of the stock market is to restrict the loss. All smart traders on the planet focus on controlling loss and riding on profit. It is an art of balancing between risk and reward. Option traders have endless possibilities to keep their trade balanced always because of the nature of options. Different types of options like call, put, At-the-money, out-the-money, In-the-money strikes etc. are available to protect existing trades or create new positions using hedging techniques.

Synthetic hedging techniques provide numerous permutation- combination to create perfect hedging position. Usually Long and Short Gamma methods are very popular amongst delta hedgers.

Future contracts can be bought with selling equivalent delta value call options or buying equivalent delta value put options. Then with every price change, the delta can be made neutral with managing gamma. If an option is bought in hedging strategy, it is called as Synthetic long hedging technique and known as Long gamma strategy.

Future contracts can be sold with buying equivalent delta value call options or selling equivalent delta value put options Then with every price change, the delta can be made neutral with managing gamma.  If an option is sold in hedging strategy, it is called as Synthetic short hedging technique and known as Short gamma strategy.

Short gamma strategy: In short gamma position, it is preferred to have the less volatile market and hence Implied volatility settles with the time. It will result in decreasing Vega with time and convert Vega difference into the profit. If this position will run until the expiry of the series, theta is increased with time and it will directly convert into profit over a period of time. It has only one dangerous zone where loss can occur and that it managing gamma. In short gamma strategy, with every price movement of spot price, gamma should be managed to keep delta neutral. It is important to buy equity worth gamma quantity at a higher price and sell at a lower price.  So, this is the possible area where profit is decreased. It is advisable to create short gamma position when the market is stable or less volatile.

Long gamma strategy: In Long gamma position, it is preferred to have a more volatile market and hence Implied volatility rises with the time. It will result in increasing Vega with time and convert Vega difference into the profit. If this position will run until expiry, theta is increased with time. Theta is negative for long gamma position so here are the chances of decreasing profit.  But the most beautiful point is gamma management. In long gamma strategy, with every price movement of spot price, gamma should be managed to keep delta neutral. It is important to buy equity worth gamma quantity at a lower price and sell at a higher price.  So, one can enjoy more profit in case of more movement in the price. It is advisable to create a long gamma position when the market is projected to be more volatile due to economic events, panic news, result seasons etc.

In synthetic hedging strategy, Gamma is a decisive factor to determine on profit. Apart from technical parameters of the position, it also depends on option delta hedgers’ skill to manage gamma for making delta neutral. Gamma management is very crucial in case gap -up or gap-down market seen over the night.

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