Gamma Scalping: How to Use in Trading, Strategies, Formula, Examples and More

14 min read

By Chainika Thakar

Are you ready to dive into the thrilling world of options trading and ride the waves of short-term price movements? Look no further than gamma scalping! It's an exciting strategy that allows traders to actively manage their positions and capture potential returns while maintaining a balanced gamma exposure.

Imagine yourself as a savvy trader, equipped with the knowledge and skills to navigate the unpredictable market. With gamma scalping, you gain a powerful advantage. By understanding how gamma and delta interact, you can fine-tune your strategy and ride the exciting waves of short-term price swings.

But why is gamma scalping so relevant in today's dynamic markets?

Well, think of it as your secret weapon for thriving in a volatile market. When the market is unpredictable and prices are swinging, gamma scalping helps. You can adjust your positions to rebalance the portfolio.

All the concepts covered in this blog are taken from this Quantra learning track on Options Trading Strategies In Python: Advanced. You can take a Free Preview of the course.

Get ready to embark on an exciting journey into the realm of gamma scalping with this blog that covers:


What is delta?

In order to learn about gamma and gamma scalping, you must first get an understanding of delta.

Delta reflects the sensitivity of an option's price to variations in the underlying asset's value. It measures the change in an option's price for a one-unit change in the underlying asset's price.

Delta values range from -1 to +1 for puts and calls, respectively.

  • A delta of +1 indicates a direct correlation between the option's price and the underlying asset's price.
  • A delta of -1 suggests an inverse relationship.

Delta also serves as an estimate of the probability that an option will expire in-the-money, with a higher delta indicating a higher likelihood of in-the-money expiration.

"In-the-money expiration" refers to an options contract having intrinsic value at its expiration.

For call options, it occurs when the underlying asset's market price is higher than the option's strike price. For put options, it occurs when the underlying asset's market price is lower than the option's strike price. Traders can increase their return by exercising or selling these options at expiration.

To learn more about the basic terminologies used in options trading, you can check out this video below.

This video above will help you gain enough knowledge to navigate through this blog easily if you're new to options trading.


What is delta scalping?

Briefly speaking, delta scalping is a trading strategy used by experienced traders in options and futures markets. It involves closely monitoring the delta of a contract, which indicates its price sensitivity to the underlying asset's movement.

Traders buy the contract when the delta is positive and sell when it's negative, aiming to get good returns from short-term price fluctuations. It requires quick decision-making and risk management.


What is gamma?

Gamma measures how fast an option's delta changes when the underlying asset's price moves. It shows how sensitive the option's price is to changes in the underlying asset's value.

A high gamma value indicates greater delta sensitivity and more significant price fluctuations, while a low gamma value suggests less delta sensitivity and smaller price movements.


What is gamma scalping?

Gamma represents the rate of change in an option's delta in response to underlying asset price changes. Gamma scalping is an options trading strategy where traders adjust their options positions to maintain a neutral gamma exposure. The neutral gamma implies a position or portfolio of options contracts where the overall gamma value is approximately zero.

The goal of gamma scalping is to receive good returns from short-term price movements of options by taking advantage of changes in gamma and delta.

You must be wondering “what is delta?”

So, let us discuss the meaning of delta briefly and then proceed.


Formula of gamma scalping

​​The formula Δ = Γ * ΔS expresses the relationship between delta, gamma, and the change in the underlying asset's price. Gamma amplifies the impact of price movements on an option's delta.

In this formula,

  • Δ represents the change in the option's delta
  • Γ represents gamma and
  • ΔS represents the change in the underlying asset's price.

Essentially, gamma magnifies the impact of price movements on an option's delta. The core concept of gamma scalping involves continuously adjusting options positions to maintain a neutral gamma exposure, thus capitalising on short-term price movements while managing risk effectively.


Example of gamma scalping

Let us learn gamma scalping with an example.

John is a trader with a portfolio of options that has a neutral gamma position. If the price of the underlying asset increases, the gamma of the options also increases. To maintain a neutral gamma exposure, John would sell some options to offset the increased gamma. This allows the trader to secure good returns and maintain the desired risk level.

On the other hand, if the price of the underlying asset decreases, the gamma of the options decreases as well. In this scenario, John would purchase additional options to rebalance the gamma exposure. This enables the trader to benefit from the falling prices and potentially retrieve good returns from subsequent price rebounds.

In brief:

In gamma scalping, traders actively monitor the gamma of their options positions for an increase or decrease in gamma.

Gamma scalping and price of underlying
Gamma scalping and price of underlying
  1. Price of underlying asset goes up, gamma of options also goes up:

In this case, the trader sells some options to offset the increased gamma.

2. Price of underlying asset goes down, gamma of options also goes down:

In this case, the trader buys some options to rebalance the gamma exposure.


Steps to use gamma scalping in trading

To effectively utilise gamma scalping in trading, it's important to follow a systematic approach. In this section, we will explore a step-by-step guide on how to use gamma scalping in your trading strategy. These steps will provide you with a solid foundation to implement and adapt the strategy based on market conditions and your risk management preferences.

Let's dive in and discover how to implement gamma scalping:

Implement gamma scalping
Implement gamma scalping
  1. Understand Gamma and Delta

Familiarise yourself with the concepts of gamma and delta. Gamma represents the rate of change in an option's delta in response to changes in the underlying asset's price. Delta measures the sensitivity of an option's price to changes in the underlying asset's price.

2. Choose an Underlying Asset

Select an underlying asset that exhibits sufficient volatility and liquidity. Stocks, indexes, or exchange-traded funds (ETFs) are common choices for gamma scalping.

3. Set Up Options Positions

Establish a portfolio of options positions with a neutral gamma exposure. This typically involves combining long and short options contracts to offset gamma effects and maintain a gamma-neutral stance.

4. Monitor Gamma Exposure

Regularly monitor the gamma exposure of your options positions. Use options pricing models or online platforms to track changes in gamma as the underlying asset's price moves.

5. Risk Management

Implement risk management techniques such as setting stop-loss orders to limit potential losses. Regularly review and adjust stop-loss levels as market conditions evolve.

6. Market Monitoring

Stay informed about market conditions, including volatility, upcoming events, and economic news that could impact the underlying asset. This information helps you make informed decisions and adjust your gamma scalping strategy accordingly.

7. Regular Evaluation

Continuously evaluate the performance of your gamma scalping strategy. Analyse historical data, track the effectiveness of adjustments and refine your approach based on market conditions and feedback.

8. Practice and Learn

Like any trading strategy, practice and experience are essential for success. Start with small positions and gradually increase your exposure as you gain confidence and refine your skills.


Gamma scalping in trading with Python

Let us check out the gamma scalping strategy in trading with Python now.

Step 1 - Import the libraries

Step 2 - Read data

Here we collect the data from nseindia and save it as a CSV File.

Data for Nifty
Data for Nifty

Step 3 - Calculate time to expiry

We convert the trading date ('Date') and expiry date ('Expiry') into a datetime object and then, calculate and store the time to expiry in days.

Step 4 - Determine ATM strike price

In this step, we determine the ATM strike price of the option. We will consider the strike price nearest to the future price to be ATM. This step is required so that we can take positions in the ATM straddle.

After this, you compute the implied volatility, delta and plot the daily delta.

Then, you will compute the strategy PnL with these steps:

Step 5 - Compute the strategy PnL

The steps followed to compute the strategy PnL are as follows:

  1. PnL from the straddle (Call PnL + Put PnL)
  2. PnL from the Nifty futures
  3. Strategy PnL = straddle PnL + Nifty futures PnL

The strategy PnL will be visualised like this:

Strategy PnL
Strategy PnL

This graph above shows that the strategy helped with good returns over a period of time. The cumulative returns made through this strategy are INR 1000.

To check and use the entire Python code, you must enrol in our course on Options trading strategy in Python: Advanced. You will find the entire strategy code in Section 5, Unit 9.

Moving ahead, let us find out the difference between gamma scalping and delta scalping.


Gamma scalping vs Delta scalping

Now, let us see the difference between gamma scalping and delta scalping.

Aspect

Gamma Scalping

Delta Scalping

Primary Focus

Managing and maintaining a neutral gamma exposure

Managing and maintaining a neutral delta exposure

Objective

Getting good returns from short-term price movements through gamma and delta

Getting good returns directly from changes in the underlying asset's price

Key Metric

Gamma (rate of change of an option's delta)

Delta (sensitivity of option price to changes in underlying price)

Risk Management

Balancing and optimising risk by monitoring gamma exposure

Balancing and optimising risk by monitoring delta exposure

Market Condition

Well-suited for volatile markets with frequent price fluctuations

Can be applied in various market conditions and volatility levels

Strategy Complexity

Involves actively managing gamma and delta exposures

Requires monitoring and adjusting only delta exposure

Trading Preference

Preferred by traders focusing on volatility-driven strategies

Suitable for traders seeking direct exposure to underlying price

It's important to consider that the choice between gamma scalping and delta scalping depends on individual trading preferences, market conditions, and risk/reward objectives.

Traders may utilise one or both strategies based on their specific needs such as risk management approach, preferring to go long or short, etc. and market outlook such as high volatility, directional bias, etc.


Risk management with gamma scalping

Risk management plays a vital role in gamma scalping, where traders actively manage options positions to maintain a neutral gamma exposure.

Traders should have a comprehensive understanding of the risks involved, monitor positions diligently, and adapt risk management techniques accordingly to maintain a disciplined and controlled trading approach and avoid heavy losses.

Here are some of the risk management techniques that can be used with gamma scalping:

Risk management
Risk management

Position Sizing

Determine an appropriate position size based on risk tolerance and account size. Avoid overexposure by ensuring your positions are not too large, in order to reduce the potential for significant losses. (Learn position sizing in trading in detail in the Quantra course).

Implement Stop-loss Orders

Use stop-loss orders to define exit points if the market moves unfavourably. Set predetermined price levels to limit potential losses and regularly review and adjust them as market conditions change.

Monitor Gamma Exposure

Continuously monitor the gamma exposure of options positions. Excessive gamma exposure can increase risk during volatile market conditions. Regularly rebalance and adjust positions to maintain a neutral gamma exposure and mitigate risk.

Manage Volatility

Stay vigilant about underlying asset volatility. Higher volatility increases the risk of larger price swings and potential losses. Consider adjusting position sizes, utilising appropriate option strategies, or implementing risk mitigation techniques during periods of elevated volatility.

Embrace Diversification

Maintain a diversified portfolio of options positions across different underlying assets and expiration dates. Diversification helps spread risk and minimises the impact of adverse price movements in a single asset.

Regular Evaluation and Adjustments

Continuously evaluate the performance of the gamma scalping strategy and make necessary adjustments. Analyse historical data, assess the effectiveness of position adjustments, and refine the approach based on market conditions and real-time feedback.

Assess Risk/Reward Ratio

Evaluate the risk/reward ratio for each trade. Seek trades with a favourable risk/reward profile, where potential returns outweigh potential losses. This ensures a positive expected value over the long term.


Pros of gamma scalping

Gamma scalping provides several advantages for options traders. Here are the pros of gamma scalping:

Capitalise on Short-Term Price Movements

Gamma scalping enables traders to maximise returns from short-term price fluctuations in the underlying asset. By actively adjusting options positions based on changes in gamma and delta, traders can take advantage of rapid price movements.

Risk Management

Maintaining a neutral gamma exposure in gamma scalping helps manage risk. Traders can rebalance their options positions to limit potential losses and mitigate the impact of adverse price movements. This risk management aspect is especially beneficial in volatile markets.

Flexibility and Adaptability

Gamma scalping provides flexibility as traders can adapt their positions to different market conditions. Whether the market is trending up, down, or sideways, traders can adjust their options positions accordingly to capitalise on short-term price changes.

Exploit Volatility

Gamma scalping thrives in volatile markets. Higher price volatility leads to larger changes in gamma, creating more opportunities of maximising returns. Traders can actively respond to and exploit price volatility through dynamic adjustments of options positions.

Enhance Options Trading Skills

Implementing gamma scalping improves traders' understanding of options and their sensitivities, such as gamma and delta. Traders gain practical experience in adjusting positions, managing risk, and interpreting market dynamics, thereby enhancing their overall options trading skills.

Diversification Benefits

Gamma scalping allows for diversification across multiple options positions and underlying assets. Spreading positions across various assets, expiration dates, and strike prices helps reduce the impact of adverse price movements in a single asset, potentially enhancing risk-adjusted returns.

Real-Time Feedback

Gamma scalping is an active strategy that provides immediate feedback. Traders can monitor market conditions, make timely adjustments, and receive real-time feedback on the effectiveness of their strategy. This allows for continuous learning and refinement of the approach.

It's essential for traders to recognise that while gamma scalping offers advantages, it also carries risks. Traders should carefully assess market conditions, implement proper risk management techniques, and adapt the strategy to their individual trading goals and risk tolerance.


Challenges of gamma scalping and the ways to overcome the same

Challenges

Explanation

Ways to Overcome

Time and Effort Intensive

Gamma scalping requires active monitoring and frequent adjustments.

Utilise tools and technology for efficient monitoring and adjustments. Automate order execution where possible.

Transaction Costs

Frequent position adjustments can lead to increased transaction costs.

Be mindful of bid-ask spreads. Choose brokers with competitive commission structures. Consolidate trades or use multi-leg options strategies to reduce transactions.

Market Timing Challenges

Accurately timing short-term price movements can be challenging.

Improve timing skills through technical and fundamental analysis. Stay informed about market news and events.

Limited Potential to maximise returns

Gamma scalping aims for smaller, incremental returns.

Set strategic targets for maximising returns. Combine gamma scalping with other strategies for higher potential to maximise returns.

Psychological Pressure

Active nature of gamma scalping can create psychological pressure.

Maintain a disciplined trading mindset. Implement risk management techniques. Practise emotional control.

Reduced returns in Low Volatility

Gamma scalping may generate limited returns in low volatility.

Adjust strategy based on market conditions. Explore alternative approaches during periods of low volatility.

Complexity for Beginners

Gamma scalping involves complex concepts, challenging for beginners.

Invest in education and knowledge. Seek guidance from experienced traders or mentors.

By understanding these cons and implementing the suggested techniques, traders can effectively navigate the challenges associated with gamma scalping and optimise their trading approach.


FAQs on gamma scalping

Gamma scalping might be a bit confusing for some of us. Let’s go through a few commonly asked questions to improve our understanding.

What is the positive gamma?

Positive gamma occurs when the gamma value of an options position is greater than zero. It means that the rate of change in the delta increases as the underlying asset price moves.

What is the negative gamma?

Negative gamma occurs when the gamma value of an options position is less than zero. It means that the rate of change in the delta decreases as the underlying asset price moves.

What is the short gamma position?

A short gamma position refers to having a net negative gamma exposure. It means the options position is more sensitive to changes in the underlying asset price, resulting in higher risk and potential losses if the market moves unfavourably.

What is the long gamma position?

A long gamma position refers to having a net positive gamma exposure. It means the options position is less sensitive to changes in the underlying asset price, providing potential opportunities for maximising returns if the market moves in the desired direction.

What is the importance of gamma scalping in options trading?

As discussed above, gamma scalping is important in options trading for several reasons:

  • Risk management: Gamma scalping helps traders manage risk by maintaining a neutral gamma exposure, reducing the impact of adverse price movements.
  • Potential to maximise returns: It allows traders to capitalise on short-term price fluctuations and get good returns from changes in gamma and delta.
  • Volatile market advantage: Gamma scalping is particularly beneficial in volatile markets where price swings offer more opportunities for potential returns.
  • Flexibility and adaptability: Traders can adjust positions based on market conditions, allowing them to take advantage of different market scenarios.

How can I learn more about the implementation of gamma scalping?

To learn gamma scalping, consider the following steps:

  • Study options and greeks with the help of online courses, blogs, books, etc.

Understand the concepts of options, delta, gamma, and the gamma scalping strategies and techniques. You can enrol in our free course on Options Trading Strategies In Python: Basic to learn about options in detail and get started. After the basic course, you can move to the intermediate course titled Options Trading Strategies In Python: Intermediate.

  • Learn from experienced traders and online communities

Seek guidance from experienced traders and learn from their experiences. Another option is to become a part of online communities to gain insights, learn through various community threads etc.

  • Attend workshops or webinars

Participate in workshops or webinars conducted by experts in options trading and gamma scalping for interactive learning experiences. Remember that learning gamma scalping is an ongoing process that requires continuous practice, observation, and adaptation to market conditions.


Bibliography


Conclusion

Gamma scalping offers traders an exciting opportunity to capitalise on short-term price movements in the financial markets. By actively managing positions and maintaining a balanced gamma exposure, traders can ride the waves of opportunity while mitigating risk.

With a deep understanding of gamma and delta, combined with effective risk management, gamma scalping can become a valuable tool in your options trading arsenal. So, dive in, master the strategy, and unlock the potential for successful trading adventures.

For learning more about gamma scalping, you can explore our course on Options Trading Strategies In Python: Advanced. With this course, you will learn to create successful Option trading strategies using quantitative techniques. You will learn Gamma scalping strategy and more in detail.


Disclaimer: All data and information provided in this article are for informational purposes only. QuantInsti® makes no representations as to accuracy, completeness, currentness, suitability, or validity of any information in this article and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages arising from its display or use. All information is provided on an as-is basis.

AI-Powered Trading Workshop 2024