Reverse gamma scalping is the opposite of long gamma scalping, and it is usually implemented by traders who want to sell options as they believe implied volatility levels will decline.

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4. Gamma scalping is an attempt to
adjust the deltas in a long options
position so that the trader can
overcome the effects of time decay.

8. RGS Definition
Reverse gamma scalping is the opposite of
long gamma scalping, and it is usually
implemented by traders who want to sell
options as they believe implied volatility
levels will decline.

9. The further down the market goes the
longer the market you will be getting – not
something one wants in a declining market.
On the flip-side, as the market advances
higher the position will be getting shorter
and shorter.

10. Margin
The downside to selling straddles is:
1. Unlimited Risk
2. Margin

11. One way to protect yourself is to simply buy
tails, that is out-of-the-money options to protect
the position. For those starting with small
amounts of money, it is imperative to purchase
the tails for protection as the margin can be
heavy, especially if trading indexes.

13. When To Reverse
Gamma Scalp?

14. The obvious answer of when to gamma
scalp is when volatility levels are high and
you have reason to believe that they will
decline shortly. A decline in volatility levels
will usually only result when the market
advances or stabilizes.

16. Best Way To Learn is Through
Example:

17. Step #1
Suppose you have been watching IBM and
wanted to sell volatility in that name once the
market and the stock have hit a possible
bottom, if only a temporary one. On November
19th the stock appears to be at a bottom at
$75.97 so you decide to sell the $75 straddle
for $13.

19. Step #2
Given: Sell 10 December 75 straddles
Since the stock is a tad above $75 our straddles
will have a slight short deltas.
We will short gamma, meaning if the market
goes up we get short deltas, if the market goes
down we get long deltas.

21. Step #3
We look at our broker's sight to get the
greeks.

22. Step #4
We need to get our original net delta and
gamma. Though we do not need to know our
vega and theta at this time (for remedial
reverse gamma scalping), it helps to know
when managing large portfolios of various
options positions.

24. Step #5
Since we know that when the market collapses
in the underlying the volatility levels will
increase to our disadvantage. We also know
that if the market in the stock advances the
volatility levels will likely decline to our
benefit. For this reason we will prefer to keep
a slight short delta if possible, even if the
market is running higher.

26. Step #6
We decide to be constantly short the
equivalent of 100 shares of stock. Though this
is not practical as it would require huge
amounts of trading small quantities of shares.
We know that every dollar move in the stock
will mean our delta is going to change by 40
shares (because of our short 40 gamma).

27. Step #7
We decide we do not want to trade anything
less than 100 shares of stock, which comes out
to adjusting every time the stock moves
roughly $2.50 (100 shares / 40 gamma = 2.50).

28. Step #8
Now we allow the stock to move.
Notice above that
the stock did start
higher once we sold
the straddles, which
is in our favor.

29. Step #9
We mentioned earlier (step #7) that we are not
going to adjust our stock position unless the
stock moves $2.50 or more. The good news
regarding this particular example is that over
the course of 2 weeks the stock only moved
more than $2.50 in a day just a handful of
times.

30. We started out with a negative delta which is
to our disadvantage knowing from hindsight
that the stock went up, but that is fine and we
had no initial stock position.
As the stock goes up $2.5 we will buy shares
and sell when the stock is down $2.50.

32. Step #10 (November 28)
On November 28 the stock opened higher and
when it was up $2.50 we were suppose to buy
100 shares. The stock closed up $5.01 so we
ended up buying another 100 shares (for a
total of long 200) on the close.

33. Step #11 (December 1)
The stock opened lower and when it was down
$2.50 we had to sell 100 shares. The stock
closed close to down $5, so we will sell another
100 shares on the close, thus flattening out our
position. You will notice that we bought 200
shares and sold 200 shares and are currently
down/lost $219. This is the negative aspect of
reverse gamma scalping.

35. Step #12 (December 2)
The market closed up $2.94. To make the math
easier, and to add realism that we can not buy
and sell stock exactly in $2.50 increments, we
decided to leave a little money on the table
and only buy shares on the close.

36. Step #13 (December 8)
Another up day in the stock. When the stock
got to $82.34 we bought another 100 shares.
We now have 200 shares in position. Since the
stock never made it up a full $5 we didn't buy
another 100 shares, but we will do it on the
close.

38. Math
This is the math of the stock trades
(independent of the option profit and loss).

39. Step #14
We now know that the stock is up roughly $10
from when we sold the straddles at $13, and
we are getting a tad nervous, so we look back
at how our options are doing.

40. Important Points
Straddle Profit
Notice that the straddle we sold for $13 is
now trading at $11.25, thus making $1.75
per share. The profit is not exactly a
home run, but decent considering the
stock did have a very strong run higher.
We made $1,750!

41. Stock Profit
We made $354 on the stock. This
too is not a home run, but was
important should the stock have
gone even higher than $88, our
break-even point on the straddle.

42. Conclusion
When practicing reverse gamma scalping, there
are some tricks that we learned over the years
that will help you stay safer.

43. ONE:
One can use options instead of shares to
hedge. This is very important for those with
tighter margin restrictions. If confused or
forgetting how this process works, simply go
back to your blue book.

44. TWO:
Do I keep short deltas even in a bullish market?
You want to keep the short deltas on even if
the market is going up, but the danger is not on
the bullish side. The collapse in volatility should
more than offset any loss due to having a short
delta in a bullish market

45. How many short deltas is the right
amount to carry in position?

46. How many short deltas is the right amount?
There is as very scientific way of calculating this
estimate, but it requires too much work. When
the markets are zipping around no trader we
have ever seen pulls out a calculator and starts
doing tricky math. Here is a shortcut.

47. ONE
Find the range in the stock and find the range
in volatility over a couple month range. You can
also do this for a year's time too, simply to
have a second number which can then be
averaged with the first.

48. TWO
Divide the range in the volatility (as measured
in percent) by the dollar range in the stock.
Suppose over 2 months the stock had a $20
range and the volatility ranged from 60% to
70%, or 10% range. The math looks as follows:
10 / 20 = 0.50

49. THREE
This means that for every dollar move in the
stock you can expect volatility on AVERAGE
(and very generally speaking) increase or
decrease by 0.50% points.

50. FOUR
Find the vega for the straddle adding both the
call and put vega together). In the IBM example
above the vega on the call was 0.09 and the
vega on the put was the same. This gave a total
straddle vega of 0.18. On 10 straddles this
works out to be $180 (10 straddles X 100
shares per contract X 0.18).

51. FIVE
Multiply step 2 (0.50) by step 4 (180) to get a
total of 90 shares. This is the number of shares
that you want to be short at a maximum.

52. SIX
In addition, you will never want to have your
delta greater than 2 times your gamma. This is
done to avoid the position from running away
from you.

53. SEVEN
Because the maximum short delta came out to
be 90, but our gamma in the previous example
was 40, we don't want to exceed 80 shares.
(gamma of 40 * 2 = 80).

54. Keep in mind that trading stock in shares not
equal to 100 share even increments is a hassle
and you are better off (because of price and
liquidity) to simply round up or down. Step 6
and 7 are primarily for those trading very large
positions.

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