Published on March 13, 2014
Why Being Short GAMMA is a bad specula9ve idea over the long term Made by a “Theorist” Dedicated to all the “Prac9cal People” Powered by: N.N. Taleb Best works with Free Adver9sing: Fannie Mae, Indy Mac and Lehman Brothers
The main idea behind any strategy that involves wri9ng (short gamma) an out of money op9on is to put up a collateral and generate posi9ve cash ﬂow that can be reinvested while the expecta9on of op9on exercise is strongly biased towards ending out-‐of-‐ money.
In other words, for only a frac9on of the no9onal value of a contract, op9on sellers are willing to assume from their counterparty the risk of any expected or unexpected move in the underlying. They assume a large move is highly unlikely.
A general problem with this kind of strategy is they predic9vely yield a CAPPED GAIN while assuming UNCAPPED CAPITAL RISK.
The consequence: Decep9vely steady income that can last for sustained periods (if the vola9lity is low*), sudden unlimited capital loss**. * Like right now, March 12th, 2014 ** Like the one on October 19th 1987, October 15th 2008, August 31st 1998, August 8th 2011, etc. Out of TOP 20 historically largest S&P500 daily loses, 11 happened aber 2007. All in excess Of 5.00%. The risk of capital loss is not only limited to the contract itself but also to the collateral meaning there exists certain risk of correla9on in the downward move between the underlying and the collateral.
Why is this so?
Implication of being SHORT an option contract! Taleb, N (2013): No, Small Probabilities are Not Attractive to Sell': A Comment! P/L! (theta)! IV Std. Dev.!
Why Being Short GAMMA is a bad specula9ve idea over the long term! Implication of being SHORT an option contract! Expected Payoff ! from Selling an Option Indy Mac! Annual Earnings Taleb, N (2013): No, Small Probabilities are Not’ ttractive to Sell': A Comment!
The Problem: Tail Risk! Kurtosis over time: example of an “in4inite moment”. The graph shows the fourth moment for crude oil in annual nonoverlapping observations between 1982 and 2008. The instability shows in the dependence of the measurement on the observation window.
The Problem: Tail Risk! Taleb: Selected Lectures on Risk (2012) Monthly delivered vola9lity in the SP500 (as measured by standard devia9ons). The only structure it seems to have comes from the fact that it is bounded at 0. This is standard. Monthly vola9lity of vola9lity from the same dataset, predictably unstable.
The Problem: Tail Risk! Taleb: Selected Lectures on Risk (2012)
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