I had an Option Pit trader ask me how to set up the Greeks for a long gamma trade. The answer is there is no right answer, but there are more favorable answers. The key to a good gamma position is that the option trader wants the underlying to have a great realized volatility higher than the implied volatility the trade bought. The trade works well if the stock moves around a lot and front month vol remains stable. But, there are certain things traders can do to improve the trade. Here are two quickies
If IV of the options is at the very high end of the range, this does not mean that a gamma trade is a bad idea. However, the trader should set up a long gamma trade that is short raw vega, and flat weighted vega. This will insulate the spread if indeed vols do fall.
If the IV of the options is at the lower end of a range, than it might make more sense to set the trade up long raw vega and very long weighted vega. This will allow the trader to really make money if the underlying starts to move. See small example below:
There are many unique ways of trading gamma, tomorrow in the AM Pit Report I will show examples of these two set ups.
charte provided by livevolpro
