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I have been looking into options strategies that minimize risk via delta neutrality. One such strategy seems to be the gamma-neutral delta-neutral call ratio spread, in which the gamma is neutralized by buying calls with a lower strike and selling more calls with a higher strike, and the delta is neutralized by shorting the stock. As time passes, it seems like the strategy will naturally result in a profit via theta decay, since the position is theta-positive. I specifically read about this here: https://www.investopedia.com/articles/optioninvestor/07/gamm_delta_neutral.asp

Assuming these positions are opened at the start of the week and closed at the end of the week, what are the risks associated with this strategy? The only one I can think of is a huge move in the underlying that significantly alters the delta of the position, but this seems unlikely for the most part since stocks rarely make such moves in a week.

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You are generally correct in thinking that this strategy should make money most of the time, however I would warn you to be very careful with strategies that earn a small amount of money most of the time but lose many multiples of that when things go wrong. These are examples of “picking up pennies in front of a steamroller”. The options market is full of these strategies. Here are some other risks and drawbacks:

  1. You will probably need to sell many more calls than you bought to achieve your desired greeks (flat gamma + receiving a credit). I suggest you pull up option quotes on yahoo finance and see what ratio is needed yourself. One example I found is buying the Apple Aug 20th 160/175 1x3 with Apple trading \$136. You can buy this call ratio and receive a credit of 0.10. Increasing the ratio makes your drawdown when the stock actually moves up significantly worse. In my Apple example you would make ~0.02 (\$2) each week if the stock didn’t rally significantly but you would lose ~5.5 (\$550) if the stock ever rallied to \$175. This would wipe out 275 winning trades in a row!

  2. If your plan is to roll the option strategy before it expires the underlying does not need to move as much before you start losing money. Below is a chart I created using the Apple example above and this tool. Notice that even if you close the strategy in one week you will start drawing down much sooner than the expiration payoff would indicate.

Options PnL

  1. The amount of theta the structure collects in one week may not be enough to cover execution costs. Let’s look at our example, we collected 0.10 (\$10 per 1 structure) and since you are planning on closing it in one week we should only expect to collect a fraction of this if the stock stays in the same range. Let’s make the incorrect assumption it will linearly decay for simplicity's sake. This means we will get 7/52 * 0.10 in theta after one week since there are 52 days until the expiration date. This only ends up being 0.0135. My broker charges about \$2.5 per trade in an options structure like this. That means we would have lost money entering and exiting the trade in one week (\$5 in commissions vs \$1.35 in theta).
  2. There is a chance the implied vol surface reprices in a way that you lose money over one week even if the stock does nothing. This means the implied vol of the calls you sold went up significantly relative to the call you own.
  3. Since there is a possibility of unlimited loss with this strategy your broker will likely charge a hefty initial margin to hold the trade. My broker would charge me $2,750 for one structure using the Apple example. This means from a return on capital perspective the trade isn’t very good. Even if we made 0.02 every week the annualized return on capital would be something like 3.8% which is poor for a strategy with unlimited loss potential.

I highly recommend you go through checking the payoff diagram, return on capital, and execution costs with some real world data to build your intuition further. Lastly, you will be able to find opportunities that look better than my example, however it may be because the drawdown begins sooner, the ratio is higher, or the market believes a sharp move up has a higher probability than my example.

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  • $\begingroup$ Thanks a lot for the answer, much appreciated. I agree that this is not a viable strategy if you're trading longer dated options, but I believe it is profitable if you trade options with 1 week to expiry. Let me provide an example related to AT&T. If I bought 19 calls at the $29 strike and sold 62 calls at the $30 strike expiring July 9 (around 10 DTE), I would net approximately $30 every day. This seems pretty good, considering it doesn't take much to set up the trade $\endgroup$
    – Dhruv Kapu
    Jul 1 at 1:44
  • $\begingroup$ I would agree that you will be able to collect more theta trading one week out but now your ratio spread is significantly tighter and closer to the current underlying price. It will take a much smaller move before you start drawing down. In your example it is only 3% before you reach your short strike. You might also be over looking the dtheta/dtime aspect of this trade. The 30 strike calls cannot decay at the same rate every day because they are only worth a couple of ticks so you are likely overestimating the theta you will collect during the week. $\endgroup$
    – klib
    Jul 2 at 2:26
  • $\begingroup$ A shorter way to say this is that when you are trading so close to expiration there are higher order greeks that will effect your result significantly such as speed (change in gamma for change in underlying) and change in theta for change in time. $\endgroup$
    – klib
    Jul 2 at 2:30
  • $\begingroup$ So setting up a narrow spread would lead to my position having a net speed that is very high (so small moves in the underlying would alter the gamma)? Also, you're right in that the 30 strike calls are worth less (I believe only around 0.04), but since I'm selling a large number of them, wouldn't that still mean I would collect a significant amount of theta? In total, the calls that I sold would be worth 248, so a decline of 30 total per day doesn't seem too outrageous. $\endgroup$
    – Dhruv Kapu
    Jul 2 at 13:11

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