Gamma-Theta-Vol triangle

The entire concept of volatility trading can be simplified into a triangular relationship between Vol-Gamma-Theta.

Although it might seems oversimplifying a rather complex dynamic of option trading, your realized pnl will be determined by that triangle
Let's understand how this three-way relation affects your option trading pnl...

We know that volatility determines the cost of the option, so to have a profitable option strategy we first need to be on the right side of the trade (buying cheap vol, and selling rich vol), but
once we traded the option we enter the gamma-theta phase of running the day-to-day risk of our strategy...

Our premiums (paid or received) are given at inception, and we can think of the option premium as a series of T interval straddle breakeven, so to be profitable we need
either to realize above (if we are long gamma) or below (if we are short gamma).

Our Gamma is also affected by the vol, as it has inverse relation with the level of vol (the higher the vol, the lower our gamma and vice versa). If we are buying high vol, our dDelta/dSpot will be
low, so if we are long gamma we will either need meaningful move to accumulate delta, or hedge relatively small delta at a fixed% move.

This is where the gamma-theta relation comes to play... we know our daily theta, and we know our gamma, so at the end of the day our profit
is determined by the way we monetize our delta hedging (which is how we realize the volatility).

This triangle also dominates volatility cycles. As investors sell vol to lower volatility levels, their -ive gamma increases, they will have less delta-tolerance and cause
a cascading effect of higher realized volatility -> higher implied volatility (I know there is more to that, vanna/charm/dealer GEX, but for the sake of the argument I'm making that simple)

That is the reason, imo, that vol short squeeze is much more powerful than a 'normal'
one. The leverage that our gamma provides us, causes asymmetric pnl profile.

Now, I'm not trying to advocate either long, nor short gamma, but to trade volatility profitably and efficiently we need to be aware of this dynamic

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More from @VolQuant

4 May
Risk today feels bit on the soft side, and while I have literally no clue whatsoever whether this is going to develop into a sell-off today or not there are few things that worth keeping an eye on:

1. USDJPY vol has been outperforming implieds for about a week now...
when you see this kind of dynamic it's definitely a good sign for risk. wider trading range of USDJPY = more volatile USD/ TYs

2. SGD realized x2 move compared its 1m vol. We are talking about a currency that almost never moves

3. very weak HY currencies (EM, commodity G10)
4. FX vols coming of a somewhat low base, which means that gamma is cheap to own (short gamma more painful, less buffers)

5. Inflation expectations creeping higher w/ commodities but treasury yields are somewhat low
Read 4 tweets
10 Apr
While most of the people on my twitter feed are all about the next 5-10pts in ES and vanna/charm/gamma squeeze (or anything else which is the flavor of the month), very few look at a pretty big thing that can (and should) be alarming - China shadow banking
This "little" problem is something that unlike other crises, is an ongoing bubble-like train wrack that the CCP has to carefully deflate, so every few months they deleverage a bit more.

In 2015 they had to deleverage their stock market after a boom of margin retail accounts
that sent their stocks to the moon (think today's US market on steroids). After that they had to devalue their currency, which global markets really didn't like.

After that they kept on letting thousands of companies to under in a controlled way, and occasionally drained
Read 6 tweets
8 Apr
One of the biggest misconception in boxing is that the southpaw stance indicates left-hand domination (@Ksidiii should know a thing or two about that...)

Ex-soviet union coaches (Cubans are actually known for the overwhelming portion of southpaw fighters) teach from young age
boxers to fight in a southpaw stance, and I can assure you that most of them are right-hand dominant.

So you are probably asking how this is all has to do with trading, right?

Very much like in boxing, experimenting different strategies/models/market helps you develop arsenal
of tools that can become handy under different market regimes...

I'm an orthodox fighter, so my default stance a leading left hand, but I do train at least twice/week in a southpaw stance to be able working both stances. This helps me become more versatile as a fighter
Read 11 tweets
27 Mar
If you run a portfolio (no matter what you trade) the most important question you need to ask yourself is "in what situation this portfolio blows up?)

I recently took some time off the market, and besides doing a lot of housework and renovation I ran complete scenario analysis,
backtest, and stress test to my portfolio.

We tend to think that we know our strategies in-and-out and we know that in scenario X the performance will be x1 and in scenario Y the performance will be y1, but we tend to neglect the crucial part of cross effect
of the individual strategies on our entire portfolio:
1. Are there correlated strategies (either positively or negatively) ?
2. How are the greeks on the portfolio level move with respect to spot/vol? are we happy with our gamma/vega at X% move? should we mitigate some of that?
Read 7 tweets
22 Mar
Let's talk FX funding..

Today's move in $TRY is a great opportunity to talk about a rather niche segment of FX trading which is the funding cost..

Generally speaking, when we trade any FX spot (buy CCYx/ sell CCYz) the trade settles in T+2 days (except TRY and CAD who are T+1)
So if we want to keep the trade alive we need to roll the trade forward. When we roll the trade we basically borrow in CCYz and lend in CCYx. If we borrow at a lower rate and lend in a higher rate we will earn the carry (and vice versa...)
In EM, in addition to the rate differential between the key rates the market prices in additional basis in most currencies to reflect the funding risk premium of these market.

Low risk EM (CZK, ILS, PLN, CNH) will price a moderate, while premium, while market like ZAR , TRY
Read 7 tweets
15 Mar
1/n

Let's talk Realized Vol...

If there is one single most important number that we, as volatility traders, look at, it's realized vol.

The problem with realized vol is that it's one of the most biased estimators... Give two traders identical time-series and get 4 RVs
2/n

The reason this estimator is so biased is because it's highly sensitive to both sampling frequency and size (window).

Also, we can get very different result if we sample based on close-close or OHLC (open-high-low-close).

medium.com/swlh/the-reali…
3/n

So why do we use such a biased estimator, as it tends to over/underestimate the "true" realized volatility in most cases?

Over the years I came to a realization that although possible to come up with an unbiased realized variance estimator

aip.scitation.org/doi/abs/10.106…
Read 7 tweets

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