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Market Measures

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Visualizing Gamma Risk

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Today, we will discuss one of the reasons that we prefer not to hold our trades to expiration, which is the increasing gamma risk.

According to our study in 45 DTE 16 delta strangles on SPY, the gamma of our portfolio has increased 8% in the first half of the expiration cycle, and comparatively, 27% in the second half of the expiration cycle. We can decompose these theoretical numbers into more straight forward concepts like volatility and P/L.

Based on the study, the standard deviation of P/L began to accelerate from the mid-point of the expiration cycle while our P/L began to flatline. This means that we are exposed to more risk without appropriate P/L rewarding in the second half of the expiration cycle, which implies that holing our trades to expiration gives us a worse risk-reward than managing early.

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