Reverse Gamma Scalping

In a prior post I wrote about gamma scalping around a long straddle. Reverse gamma scalping is a defensive strategy that can be used for short straddles, strangles and other credit spread positions like the popular iron condor or short iron butterfly.

The way it works is really simple. Say for example that you initiate one of the short positions above, at the time you establish the position you’re delta neutral. You hope that the underlying security remains motionless during your holding period. However, that is rarely the case and price movement will work against you. Positions that have high positive theta will also have high negative gamma. What that means is that if you’re the seller of a credit position and want to profit from option decay, you’ll be at risk for large price movement.

So how do you manage your position against adverse price movement? One way is through reverse gamma scalping. You start out in a delta neutral position. Say you have sold an iron condor, as the price of the underlying moves you’ll begin to take on some delta. If the underlying moves up, you’ll become short deltas, once your position hits -100 deltas, you can buy 100 shares of the underlying and become delta neutral once again. If the underlying declines in price you’ll become long deltas and can short some shares to offset.

Remember, reverse gamma scalping is a defensive move that can help to limit losses. It is not meant to  produce additional profits to a position like gamma scalping can do to a long straddle or strangle.

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About sellacalloption

Portfolio manager and chief option strategist for Fusion Asset Management. Professional option trader with VTrader Pro, LLC.

Posted on September 25, 2012, in Neutral Income Strategies and tagged , . Bookmark the permalink. Leave a comment.

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