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Gamma Scalping 101 - Gamma, Theta Trading

Apr. 12, 2019 9:30 AM ETSPY, VIXY, VXX, XIVH13 Comments
Gontran de Quillacq profile picture
Gontran de Quillacq


  • OptionSellers, LJM, Catalyst are among the prominent fund managers currently facing litigation for their large option losses. Retail investors regularly lose their savings by shorting options as well.
  • This first article explains the gamma/theta concept, the market-maker's daily P&L, gamma scalping, historical/implied volatilities, as well as option selection.
  • The second article will explain the hidden risks: frequency of large losses, their sensitivities to gamma distribution and vol gaps, the importance of infrastructure, before concluding on dangers.

OptionSellers, LJM, Catalyst are among the prominent fund managers currently facing litigation for their large option losses. Retail investors regularly lose their savings by shorting options as well. It is time to explain a few things about the short gamma and the “gamma scalping” strategies.

This article is split in two parts for convenience:

  • Gamma Scalping 101 – Gamma/Theta Trading, is this article. It explains the concept of gamma and theta, the daily P&L of an option market-maker, and the purpose of gamma scalping. It explains the difference of historical and implied volatilities, which are the long-term roots of profitability for the strategy, as well as why and how gamma-scalpers select the options to trade.
  • Gamma Scalping 102 – The undisclosed risks, will explain the not-so-obvious risks associated with the gamma-theta strategy: large losses and how frequent they are, the impacts of the gamma distribution and of volatility increases during large moves, the importance of institutional infrastructure, before concluding on its dangers.

What you see on YouTube and probably should not do:

Derivative instruments and their local derivatives

It is difficult to talk about options without a bit of Greek math, but this section hopefully won’t be too long.

Many functions of one variable can be locally interpolated with a polynomial. It’s called the Taylor development, and it uses the function’s derivatives as parameters. As long you don’t go too far from the reference point, the polynomial is a good description of the initial function. The formula is:

Here is the Taylor development for a simple function (cosine) – the polynomial sticks well to the curve.

This is also true for functions of several variables, although expressing the multivariate polynomial quickly becomes cumbersome. For two variables and the first two derivatives (and assuming that partial derivations commute):

This concept

This article was written by

Gontran de Quillacq profile picture
Gontran de Quillacq has 25 years of experience in portfolio management, derivatives trading, proprietary trading, structured products, and investment research. He has worked with top-tier banks and hedge funds in both London and New York as a derivatives trader and portfolio manager, quantitative strategy expert. He has delivered alternative strategies in structured and hedge fund formats.Mr. de Quillacq offers expert witness, investment and education consulting services.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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Comments (13)

jmarcelo profile picture
Great articles!!!
Gontran de Quillacq profile picture
Thank you! You should check my new blog: navesinkinternational.com/...
(you can even register for the newsletter...)
Nissan Taleb describes alpha being theta/gamma for each volatility level, what is the normal value for this parameter
Gontran de Quillacq profile picture
For those interested in option trading topic, I will make a presentation on a closely related subject in NYC Mid-Town on December 10th, 2019. The title is "Defense of a loss on SVXY options".

An abstract, the venue details, the schedule and a link to register are available at the link www.navesinkinternational.com/...
Learner16 profile picture
Good introduction, thank you.
dumbo profile picture
"...when the implied (light blue) curve is above the historical (dark curve)"
I think the colors are just the opposite, needs editing.
Gontran de Quillacq profile picture
Thank you. Correction submitted to reviewers.
Convoluted profile picture
Some good points. I'm rushing to a tee time so just one quick observation.
The conventional wisdom is 'don't be short gamma.' When I was taking calculus to get my GDE, gamma wasn't a mathematical term. Nor was it used in professor Gilbert Strang's lectures on calculus. Gilbert has been teaching calculus at MIT since 1892. He even wrote a brief paper arguing that universities were teaching too much calculus.
But, in his style "may I suggest something about the second derivative?" If a local maxima/minima is to be found (assuming we know the function to set to zero), this is where the curve begins to 'bend down.' Well now, isn't this the exact spot where we should bring the hammer down? This is where NFLX shoots over 400, and the 500 strike options have jumped over the moon. And this is where the easy money is made-shorting the 'gamma.' Of course, there's even a derivative of that which can be used to hedge gamma exposure-if one is so inclined. I see your reference to the 'amplifying' behavior of gamma. That's a good term, and when traders watch an adverse move in real time, the neophyte is thinking-'get me out!' This is also the moment overly excited buyers want in, and they overpay. Well, the dust settles, the wind dies down...what was all the fuss about anyway?
Gontran de Quillacq profile picture
You will be interested in the follow-up article.
Convoluted profile picture
Great subject matter. I hope folks will read and study- the modern market has a DNA much different from a generation ago. If you don’t try to understand the dynamics at this level, one’s study of anatomy will be grade school level.
Gontran de Quillacq profile picture
You will find the follow-up article here:
I didn’t short options. Instead I took an opposite trade. I optioned my shorts. Very popular it turns out.
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