I'm new to this forum and a novice options trader. I can contribute by documenting my painful series of mistakes as I bungle and fumble while learning to walk. This is stale news to the old pros here, but should be helpful to over eager novices like myself.
BUNGLE 1 - Over Scalping Gamma Scalping
I read about gamma scalping and it sounded too easy. Instead of doing paper trades, I like to put real money on the table as I'm too eager. You can google pages that describe gamma scalping. However, they don't tell the whole story unless you have a good options trading book and you bothered reading it. In hindsight, after reading Cottle, I now understand my cardinal sin.
The scenario is as follows. You have a straddle that is slightly profitable when the price has risen slightly ie. you have generated some delta. The idea is that you can short some underlying such that you become delta neutral again. Sounds easy, I thought. I then worked out how many deltas I had generated and sold the equivalent number of stocks to be delta neutral. So far, so good.
The price started going up. I tried to liquidate my entire position as I could have exited profitably. But the market maker (MM) from hell refused to bite. His best offer was going to take a huge chunk of my profit. "To hell with the MM. I'll just scalp more gammas", I foolishly thought. So, I shorted even more underlyings.
This went on for 3 days. Suddenly, the underlying price exploded even higher. My calls were going for parity. I thought I surely can get out now as the MM can't screw me any further. I was letting my calls go for zero extrinsic value. To my horror, I could not close my position with a decent profit at all. "Where's all the gamma scalping theory gone to?", as the thought raced through my mind and I panicked.
I'm stuck. I can't exit with a decent profit. Why?
My options bible (which arrived after I got myself in this mess) provided the enlightenment. When you short your underlying, you are effectively reducing your calls and increasing your puts. If you keep scalping more gammas as the price goes up, you will end up being the equivalent of having less and less calls and more and more puts in your straddle. Pictorially, imagine your straddle tilting to the right. The saturation point is when your equivalent position is zero calls and all puts. You have converted your straddle into pure OTM puts. Worthless puts !!!!!
That's what happened to yours truly. From a 5 put/5 call straddle, I ended up with the equivalent of 9.5 put/0.5 call straddle.
Novice lessons learnt:
1. Gamma scalping is more that just shorting shares when price goes up. There is a limit and you should be aware of that limit ie. don't scalp till kingdom come.
2. Understand what synthetic equivalence means. I mean, really, really understand it. It is vital to understand that your straddle has morphed into a pure OTM put.
3. Gamma scalping should be used to reduce/compensate for your rotting theta. It should not be used to make money.
4. MMs should be hung up to dry and have their testicles fed to flesh eating monkeys .
It hurt. It really hurt. It still hurts. I walked away with crumbs when I could have had the whole cake. But it was worth it. I learnt more than any $3000 course could have told me. It only cost me my pride and my cake.
Next episode: Why I gamma scalped in the first place.