1/Long Gamma Verticals vs. Naked Options a 🧵
TLDR: Verticals have a better risk profile, and realizes gains quicker than options.
I get asked this often since I use long gamma verticals instead of naked options. I will demonstrate pragmatically instead of mathy.
Please RT.
TLDR: Verticals have a better risk profile, and realizes gains quicker than options.
I get asked this often since I use long gamma verticals instead of naked options. I will demonstrate pragmatically instead of mathy.
Please RT.
2/Thesis: For some reason you think SPY is going to drop to 420 by March. You are willing to allocate 4K of your portfolio at 100% risk in a long gamma trade at 18Mar, since the implied move in the SPY options at the 420 strike is ~$63 (your predicted move), ironically enough.
3/You are deciding between a long gamma vertical and a long put. The capital is fixed at 4K. After looking at theoretical values, etc… you like the 18Mar 451 put to buy, and you like to sell the 18Mar 421 put if you decide to do the vertical.
1st, lets evaluate the naked put.
1st, lets evaluate the naked put.
4/Each put costs $7.80 debit, and the gains seem infinite. You are never gamma negative, so it seems you are always gaining. If your thesis is correct at 420, you will realize somewhere between $11,780 and $14,600, depending on when you hit your strike (on 18Mar or today). 
5/Here’s the long gamma vertical. You buy a 451/421 vertical for $3.70 debit and the first thing you notice is that you can buy double the number of spreads for $3700. There is a cap on the gains, but using the same notation above the gains can be between $26,300 and $12,500!
6/Now to get wordy. As time goes on, the gamma of the vertical increases, making it more forgiving to timing risk on your thesis. While speed (3rd order delta) is always positive on the naked option, it is higher where it counts on the vertical... the meat of your thesis.
7/Yes, the naked option has unlimited gains, but it's realized further out. Break even at expiration is at SPY 392, a full 28 points less than your thesis level. If your thesis changes, you can roll your vertical, and keep the stronger gamma. Way more efficient.
8/The comment I always get is something like "but the short option loses money if I'm right", but you would have bought half the puts to stay within your risk bounds! The problems people have with this are strictly psychological. Such as:
9/
1. Red numbers are ok in your portfolio, the number that matters is the "Account Value".
2. If you are never happy with your sizing, you have poor risk management habits.
3. Nomo FOMO. The short leg was necessary to realize more gains.
1. Red numbers are ok in your portfolio, the number that matters is the "Account Value".
2. If you are never happy with your sizing, you have poor risk management habits.
3. Nomo FOMO. The short leg was necessary to realize more gains.
10/There are a few exceptions:
1. If you think the drop can happen immediately, you use a naked put. But the advantageous window is narrow.
2. A naked put does give more vega exposure, but if I want more vega, I sell further down the chain.
1. If you think the drop can happen immediately, you use a naked put. But the advantageous window is narrow.
2. A naked put does give more vega exposure, but if I want more vega, I sell further down the chain.
11/
3. If liquidity is an issue, you reduce slippage (price off the mid) with a naked option instead of a vertical. This doesn’t apply to SPY, but may apply to some single equities.
4. If commissions are an issue, naked options are better than verticals.
/end
3. If liquidity is an issue, you reduce slippage (price off the mid) with a naked option instead of a vertical. This doesn’t apply to SPY, but may apply to some single equities.
4. If commissions are an issue, naked options are better than verticals.
/end
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