Gamma Scalping Cypress Semiconductor: An Example of Trading a Delta Neutral, Long Gamma Options Position

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In one of today’s option mentoring sessions, one of the topics covered was the process of gamma scalping a delta neutral, long gamma options position. The client was having some difficulty thoroughly understanding the concept. To better explore the topic, we decided to simulate a very simple long gamma options position in Cypress Semiconductor (CY), and then to gamma scalp the underlying security, keeping the net position delta neutral.

Since this is purely for educational purposes, we’re not as concerned with the profitability of the strategy as we are with exploring the mechanics of gamma scalping. We will base the paper trading on real, live market prices in CY, and won’t go back and adjust trades to make the strategy look better or worse. If this isn’t already abundantly clear, please note that this is entirely for educational purposes and completely fictional. No actual trading will occur in the options or equity markets. Nor will we concern ourselves with many important details such as commissions, availability of stock lending, market liquidity, etc..

Option Position

The one and only options position will be a long position of 100 CY Mar 14 calls, purchased at a price of $1.00. The total cost is $10,000. We will hold this option position until expiration in March.

+100 CY Mar 14 calls @ $1.00

Initial Hedge

Each option has a delta of .53, so the net delta will be immediately hedged by selling 5300 shares of CY at $14.00 resulting in a delta neutral position. Over the life of the option, the option’s delta will change as the underlying security moves and as time passes (charm). We will try to gamma scalp the underlying as vigorously as possible, to offset the time decay (theta) each day.

Option Sensitivities (Greeks)

Option sensitivities for call options, from various months, with a strike price of 14, as of January 20th, 2015

Expiration Price Delta Gamma Theta Vega Imp. Vol.
Feb 20, 2015 0.70 - 0.85 0.52 0.19 -0.01 0.02 0.51
Mar 20, 2015 0.90 - 1.00 0.53 0.16 -0.01 0.02 0.47
Jun 19, 2015 1.35 - 1.50 0.53 0.11 -0.00 0.03 0.40
Jul 17, 2015 1.40 - 1.60 0.53 0.11 -0.00 0.04 0.39

Earnings

Making this example just a bit more interesting, it turns out that Cypress Semiconductor has earnings in two days (Jan. 22th). It’s unclear how this will affect our gamma scalping and ultimately the profitability of this strategy. Hopefully it will be interesting and provide an additional learning opportunity.

As is fairly typical of a stock heading into earnings, the implied volatility of the options is elevated. Where the 20 and 50-day historical volatilities are .37 and .43 respectively, the option implied volatilities for the front two months are at least ten points higher. After earnings are released we would expect implied volatility to decrease so that it’s more in line with historical volatility. Therefore, we might see implied volatility drop .10 to .12 points and the value of the option position may decrease $0.20 to $0.24 given a vega of 0.02. In other words, the option position may take a quick hit. Hopefully, the underlying will provide ample opportunity to scalp stock to offset this loss. We will see. Normally it wouldn’t be advisable to enter into this kind of a long vega/gamma trade right before earnings, after the implied volatility is already so elevated, but sometimes you learn more when things go wrong than when they go right.

Gamma Scalping

Trades in the underlying will be recorded here on a somewhat regular basis. At the end, we will go ahead and tally up the results to determine the net profitability of the strategy. Hopefully though, most of the learning will be done along the way.

Paper Trades in Cypress Semiconductor (CY)
Date Buy / Sell Quantity Price Hedge Position
Jan 20, 2015 2:34 CST Sell 5300 14.00 -5300
Jan 21, 2015 8:34 CST Buy 100 13.82 -5200
Jan 21, 2015 11:07 CST Sell 200 14.22 -5400
Jan 22, 2015 8:33 CST Buy 200 13.82 -5200
Jan 22, 2015 8:39 CST Buy 300 13.60 -4900
Jan 22, 2015 8:41 CST Buy 300 13.40 -4600
Jan 22, 2015 9:14 CST Sell 500 14.20 -5100
Jan 22, 2015 9:50 CST Sell 300 14.40 -5400
Jan 22, 2015 10:41 CST Sell 300 14.65 -5700
Jan 23, 2015 8:38 CST Sell 500 15.05 -6200
Jan 23, 2015 8:51 CST Sell 500 15.15 -6700
Jan 23, 2015 2:19 CST Sell 500 15.25 -7200
Jan 26, 2015 9:05 CST Sell 500 15.35 -7700
Jan 27, 2015 9:47 CST Buy 500 14.80 -7200
Jan 27, 2015 1:32 CST Sell 500 15.25 -7700
Jan 29, 2015 9:24 CST Buy 500 14.75 -7200
Jan 30, 2015 8:34 CST Sell 800 15.25 -8000
Jan 30, 2015 2:20 CST Buy 500 14.75 -7500
Feb 2, 2015 8:45 CST Buy 500 14.40 -7000
Feb 2, 2015 9:04 CST Buy 1000 14.10 -6000
Feb 2, 2015 9:33 CST Buy 500 14.10 -5500
Feb 4, 2015 8:33 CST Sell 500 14.60 -6000
Feb 5, 2015 2:56 CST Buy 500 14.25 -5500
Feb 6, 2015 10:28 CST Sell 500 14.70 -6000
Feb 6, 2015 1:38 CST Sell 500 14.75 -6500
Feb 9, 2015 8:47 CST Buy 500 14.40 -6000
Feb 10, 2015 8:48 CST Buy 500 14.35 -5500
Feb 10, 2015 1:40 CST Sell 500 14.70 -6000
Feb 11, 2015 9:16 CST Sell 500 14.80 -6500
Feb 11, 2015 9:59 CST Sell 500 14.90 -7000
Feb 13, 2015 8:35 CST Buy 500 14.50 -6500
Feb 13, 2015 8:36 CST Buy 500 14.40 -6000
Feb 13, 2015 12:13 CST Sell 500 14.80 -6500
Feb 18, 2015 11:18 CST Sell 500 14.90 -7000
Feb 20, 2015 12:40 CST Sell 1000 15.00 -8000
Feb 24, 2015 8:40 CST Buy 1500 14.40 -6500
Feb 24, 2015 9:38 CST Sell 500 14.75 -7000
Feb 24, 2015 1:04 CST Sell 500 14.90 -7500
Mar 2, 2015 9:56 CST Sell 1000 15.22 -8500
Mar 2, 2015 2:50 CST Sell 500 15.35 -9000
Mar 2, 2015 5:58 CST (afterhours) Sell 500 15.55 -9500
Mar 5, 2015 12:45 CST Sell 500 15.55 -10000

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