Gamma Scalping

The core mechanism involves continuously adjusting a position to maintain a delta of zero. This means the overall position's value should not change with small price movements in the underlying asset. Traders buy or sell the underlying asset to offset the delta created by their options positions.

• Long Gamma: When a trader is long options (e.g., long straddles/strangles), they are long gamma. As the underlying price moves, the delta of their position changes, requiring them to sell high and buy low to re-hedge, capturing profit from volatility.

Unlike directional trading, gamma scalping aims to profit from the magnitude of price movement (volatility), not the direction. The profit comes from the convexity of the option's price curve.

• The strategy monetizes the difference between realized volatility (actual price swings) and implied volatility (volatility priced into the options).
• It is often used when a trader believes realized volatility will be higher than what the market has priced in.

Gamma scalping requires frequent, sometimes continuous, adjustments to the hedge. This is because gamma measures the rate of change of delta.

• High Gamma: Near the money and near expiration, gamma is highest, requiring the most frequent rebalancing.
• The process is a trade-off: each rebalancing transaction incurs costs (bid-ask spread, commissions), which must be outweighed by the profits from the volatility capture.

The strategy's implementation depends on whether the trader is net long or net short options.

• Long Gamma Scalping: The trader holds a net long options position (e.g., long straddle). They profit from large price moves by buying the underlying after it falls and selling after it rises.
• Short Gamma Scalping: The trader holds a net short options position. They profit from low volatility by selling after it falls and buying after it rises, but face significant risk during large, rapid price moves.

Gamma scalping is fundamentally an interplay between Gamma and Theta (time decay).

• Long gamma positions have positive gamma but negative theta. The trader pays time decay (theta) while waiting for volatility to realize.
• The scalping profits must exceed the theta burn for the strategy to be profitable. This makes it a race against time decay.

This is the quintessential strategy for options market makers. After filling a client order that leaves them with an options position, market makers use gamma scalping to hedge the resultant risk on their books.

• By dynamically hedging, they isolate and monetize the volatility component, aiming to profit from the bid-ask spread and volatility mispricing, rather than taking directional risk.

The strategy begins by establishing a delta-neutral position, typically by buying at-the-money (ATM) options and simultaneously taking an opposing position in the underlying asset. As the asset price moves, the delta of the options changes (this rate of change is gamma). The trader then hedges by buying or selling the underlying asset to re-establish delta neutrality, capturing small profits from these adjustments.

Gamma measures the rate of change of an option's delta relative to the underlying asset's price. A high gamma means the option's delta is highly sensitive to price moves. In gamma scalping, the trader is effectively long gamma. They profit from the asset's movement because large price swings create larger delta imbalances, providing more frequent and profitable hedging opportunities. The profit comes from capturing the convexity of the option's price curve.

In centralized markets, gamma scalping is performed by market makers and sophisticated traders using algorithmic systems. Key components include:

• Liquidity: Requires deep, liquid markets for both the options and the underlying asset (e.g., SPY, AAPL).
• Automation: High-frequency adjustments are managed by automated trading algorithms.
• Costs: Profitability is highly sensitive to transaction costs (commissions, bid-ask spreads) and funding costs for the hedge.

In DeFi, gamma scalping strategies are implemented on options protocols like Lyra, Dopex, or Premia. The mechanics adapt to on-chain constraints:

• Vaults & LP Positions: Users often deposit into automated vaults that manage the delta-hedging process.
• Hedging Asset: The underlying is typically a volatile crypto asset like ETH, hedged using spot DEXs or perpetual futures.
• Challenges: Higher gas costs, slippage, and less liquidity can erode profits from frequent rebalancing.

Gamma scalping is not a guaranteed profit strategy and carries significant risks:

• Volatility Risk: Profits depend on realized volatility exceeding implied volatility priced into the option.
• Hedging Imperfection: Slippage, latency, and liquidity gaps prevent perfect delta neutrality.
• Cost Drag: Frequent trading accumulates fees and funding costs that can outweigh scalping gains.
• Gamma Scalping vs. Theta Decay: The strategy fights against theta decay (time decay); the asset must move enough to offset the daily loss in option time value.

To fully understand gamma scalping, familiarity with these core options concepts is essential:

• Delta (Δ): The sensitivity of an option's price to the underlying asset's price.
• Theta (Θ): The rate of decline in an option's value due to time passage.
• Implied vs. Realized Volatility: The market's forecasted volatility vs. the actual observed volatility.
• Delta-Neutral Portfolio: A portfolio with an overall delta of zero, insulated from small price moves.

A portfolio position where the overall delta is zero, meaning its value is initially insensitive to small price movements in the underlying asset. This is the foundational goal of gamma scalping.

• Achieved by balancing long and short positions in the underlying asset and its options.
• The gamma of the position causes delta to change as the price moves, requiring constant rebalancing (the 'scalping' action).

Quantitative measures of an option's risk and sensitivity.

• Delta: Measures the rate of change of an option's price relative to a $1 change in the underlying asset. Call deltas are positive; put deltas are negative.
• Gamma: Measures the rate of change of delta relative to a $1 change in the underlying. It represents the 'convexity' or acceleration of an option's price movement. Long options have positive gamma.

The market's forecast of a likely movement in the underlying asset's price, derived from an option's current price. It is a critical input for gamma scalping.

• Scalpers aim to profit when realized volatility differs from the IV priced into the options they sold.
• A long gamma position (e.g., long options) profits from increases in realized volatility relative to IV.

The continuous process of buying or selling the underlying asset to adjust a portfolio's delta back to zero. This is the core mechanism of gamma scalping.

• When the underlying price rises, a long gamma position becomes long delta, requiring the sale of the asset.
• When the price falls, it becomes short delta, requiring the purchase of the asset. Profits are captured from these hedging trades.

The rate at which an option's value erodes as time passes, all else being equal. It represents a daily cost for option buyers and income for sellers.

• In a typical gamma scalping setup, a trader is long options (negative theta, paying decay) and short options or delta-hedging (to offset).
• The scalper must generate enough profit from delta hedging to overcome the cost of theta decay.

A pattern in implied volatility across different option strike prices. A 'smile' shows higher IV for out-of-the-money (OTM) puts and calls; a 'skew' shows higher IV for OTM puts.

• This affects the pricing and gamma profile of options at different strikes.
• Scalpers must account for this when constructing their options positions, as it influences hedging costs and potential profit from volatility shifts.