Category: Theta Scalping

Questions about the Greeks

QUES: In your trading experience with both the iron condors and double calendar spreads have you found it any more advantageous to theta scalp if I have time daily to monitor?

ANS: I don’t theta scalp a double calendar or an iron condor since they already have long calls or puts that protects your position while theta is collected. I will typically only theta scalp by selling a straddle or strangle. Then buy or sell the stock or etf to offset the delta/gamma risk.

QUES: My own experience is that theta scalping (even at 250 or 300 delta
intervals) have not routinely produced _greater profitability_ vs adjusting via spreads near/around the break-even zones.

ANS: I agree. It is not as profitable as adjusting spreads at break-even points.

QUES: I am a very active gamma trader and have been employing my own gamma/theta/volatility algorithm to adjust my gamma positions.

ANS: I have recently been using a formula that has helped determine when to adjust deltas based on volatility and estimated moves of the stock rather than intervals of 250-300 deltas. I have found it to be excellent. Feel free to test it for yourself.

I’d be interested in your algorithm, if you’re willing to share.

The formula I’m using is simply this: E= ([V/16]*St)*R

16 is the sqrt of 256= the average number of trading days in a 1 year period.
V= Volatility (expressed as a percentage), E= Estimated Move of the Stock or ETF on any given day, St=Stock Price, R=Risk Tolerance (the amount of risk you want to assume above an estimated one day move in the stock before hedging deltas. This can be 1,2 or 3 or 4. I don’t recommend a R value above 4)

If I was selling a straddle:
V=.2054
St=50.00
R=2

Then
E= ([.2054/16]*50)*2
E= 1.28

So, on this day, I would make an adjustment only after a move of 1.28 based on a R value of 2 on the stock or etf on that day and recalculate for the next day based on price change and volatility change.

Closing is easy. I close the position when the theta collapses.

Options Trading Questions

1) I understand that you initiate your positions 30-40 days prior to expiration but you also talk in your videos about adding to your positions. Are you referring to adjustments that may become necessary due to a breakeven being threatened? If not, could you explain?

ANS: I only add to positions to increase my profits and if I feel confident that the adjustments will result in a better trade.

2) How do you decide whether you should structure an Iron Condor or Double Calendar for a given ETF?

ANS: If volatility is high and falling I will use an iron condor. If volatility is moving sideways I will use a DC.

3) I’m wondering what your capital allocation guidelines are. Of your total investment capital, what percentage do you allocate for the monthly income system? Of that, what portion do you reserve for initiating positions and what percentage for adjustments?

ANS: I use about 20% of my total available capital on initiating monthly incomes trades. I set aside an additional 10% for adjustments.

4) What has your experience been in terms of being exercised? Has it happened very often? If it does happen I’m a little fuzzy on how to deal with it. Could you clarify?

ANS: You will not get exercised unless your short option has less than
.25 of intrinsic value or it’s close to a dividend payout. It doesn’t happen very often and actually almost never with etf’s. If it happens I simply sell the shares and close my long option position.

5) After reviewing the Theta Scalping video on module 11 I just want to be sure of what you’re doing. If I understand correctly you initiate a position 30-40 days prior to expiration, then adjust if necessary for the next couple of weeks and then in the final 2-3 weeks you will buy/sell deltas using the underlying to remain delta neutral. Is this correct?

ANS: When scalping theta you have to make adjustments when your deltas tell you to. You can’t wait until the last 2 weeks, you have to adjust when it’s necessary. The goal is to adjust as little as possible so that you make more money from the theta you collect than the losses you’ll have from adjusting deltas.

6) During especially volatile periods like late 2008/early 2009 do you still put on monthly income type trades or do you wait for volatility to wane a bit first?

ANS: Please see the Market Report 11-22-08

Theta Scalping Question 1

Q: Towards the back of the video, you indicated an adjustment of adding 300 shares of QQQQ stock. You had 60 contracts open. If I wanted to know how many shares would be required for one contract, would I divide the 300 by 60, or 30, or 15? I would assume divide by 15, since for the iron condor you used needed a long and short for the puts and the calls, or 4 contracts for one condor.

A: Adjusting for theta scalping positions has nothing to do with the number of contracts in your position, it has to do with deltas.

In the video you reference I was probably ‘short’ 300 deltas that’s why I needed to buy 300 shares.

In order to determine the number of shares when theta scalping you need to know your deltas.

The delta will tell you what you need to get back to a delta neutral position

For example if you’re short 300 (displayed on TOS as “-300”) 300 deltas then you would need to purchase 300 shares to be ‘neutral’ and if you were long 300 (displayed on TOS as “+300”) then you would need to sell 300 shares (short) to be delta neutral.

However, and this is important, it is not alway wise or preferable to be perfectly delta neutral. You need to know the bias of the market at any one time. For example the market bias since March 9 has been ‘up’…
you would have done well by understanding the current market bias and trading accordingly by being slightly long (positive) deltas at all times.

The market bias can be either:

1) Long (up trending)
2) Short (down trending) or
3) Neutral (trading range bound)

The bias changes week to week, month to month so it’s important to know the current market bias that’s why the daily market videos I do are so important to all option traders. You need to know the bias.

Hope that helps