Gamma Rent (alpha)

T

Tb2018

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Gamma Rent​

A risk measure for options which is computed by relating an option’s theta to its gamma:
Gamma rent = decay/gamma
This second-order greek , which is also known as alpha, expresses the quality of gamma in terms of the time decay (rent). Therefore, it indicates the quality of the earnings from gamma for one dollar invested in options for one day. A high gamma rent implies that the premium receiver does not receive sufficient earnings for the costs of the decay. A low gamma rent reflects the fact that the option trader is getting more for less (more gamma and less theta). Typically, generating higher gamma rents (for sellers) and lower gamma rents (for buyers) can be achieved by buying options for low premiums and selling options for high premiums.
 
I also use another metric:

GRVOL=Gamma rent/Volatility

You will see that this evolve at different delta values in a very different way !

Happy trading!
 
More on the point:

In the Black-Scholes model the price of long gamma is greater time decay (theta) and vice versa.

  • So if you are long gamma, you pay time decay.
  • If you're short gamma, you earn time decay.
And it doesn’t matter if your are talking about a single option or a combo or a portfolio.

(Though I'm assuming no financing costs and a delta hedged strategy for simplicity).

But that's only in the Black-Scholes world. In the real world there is a more complex relationship to the point where you can create vanilla options strategies that are long gamma and earn time decay.

To recap now you could be:

  1. Long gamma, paying decay
  2. Long gamma, earning decay
  3. Short gamma, earning decay
  4. Short gamma, paying decay.
Now most traders only have intuition for 1 and 3 as in Black-Scholes, so get hit accidentally by 2 and 4. If they get the gift of 2, they claim special skill, but if they get hit by 4, they moan and claim system glitch.

However, most are totally unaware because most systems do not provide the correct smile adusted gamma and decay and traders as well do not attempt P/L reconciliation against the displayed Greeks.

So they are either accidentally making money, or accidentally losing money.
 
Tb2018, interesting take.
I intend to dive into the concepts you presented when time allows. Here are some 'off the hip' comments, reactions of mine.

Important foundation here is a notion that BS model, when applied standard way, can lead a trader to make false decisions.
The main thing, in my opinion, is that all t-lines derived from the model are not static. This feature is embedded in 'the whole picture' of options modeling and does not matter what changes to the model you apply. I refer to this as t lines being flexible and the only rigid thing is an expiration graph. You mentioned it.
I also believe _all_ options traders do know this but act as t-lines were rigid anyway.

There can be many approaches to this 't-line flexibility' issue. Most common, imo, is to gain experience, that is to consciously observe what happens with your greeks over time in real not on the modeled graphs.
Theta is, yet again, imo (but all I say is 'imo') the most missunderstood of the greeks. In my take theta is a measurement of ' flexibility state of t line' - but it depends... :)
I guess I sound like babbling...

Thanks for the post. I didn't really thought of actively seeking long gamma, earning decay trades. I avoid quant's approach for practical reasons but there might be something in what you wrote to use quant method to find those trades.

Indeed this is very interesting idea... Wonder if you've already found systematic way to scan option chains for opportunities. Maybe you can share some examples of configurations giving long gamma, earning - structures.
 
Now that many trades are 0DTE this is even more essential to understand.

Happy Trading
 
Tb2018 said:
Gamma rent = decay/gamma
This second-order greek , which is also known as alpha, expresses the quality of gamma in terms of the time decay (rent). Therefore, it indicates the quality of the earnings from gamma for one dollar invested in options for one day. A high gamma rent implies that the premium receiver does not receive sufficient earnings for the costs of the decay.
Click to expand...

Don't you have that backward? High gamma rent means theta (decay) is high and/or gamma is low, which is what the premium receiver (seller) wants.
 
Mark17 said:
Don't you have that backward? High gamma rent means theta (decay) is high and/or gamma is low, which is what the premium receiver (seller) wants.
Click to expand...
You are right Finpedia type error!
HIGH GAMMA RENT (ALPHA) = OPTION BUYER 👎
LOW GAMMA RENT=OPTION BUYER 👍
 
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