Deconstructing a Quanta-mental Options Trade

Take an inside look at the exciting fusion of quantitative theory and practical, intuitive trading.

In my last post, I mentioned how I decided that it was time to close the textbooks and start applying what I learned to the actual hands-on skill of trading. A week later and that decision seems to be paying off.

Background — Option Velocity

To execute this strategy, I first started thinking of ways to best capture premiums. I knew that it would be much easier and more sustainable to bet on what an asset probably wouldn’t do, than to consistently bet on what it will, so naturally, I used credit spreads as the baseline. I also wanted to make sure that the strategy would have a very short holding period, ideally intraday, so this meant I had to focus on the variable(s) most responsible for large, intraday profits.

Speed

Speed, a third-level Greek, is essentially the gamma of gamma. It measures how much gamma changes based on moves in the underlying stock. To better understand this, it might help to see a visual example:

First, the price of the option changes by the delta value, so from $1.00 to $1.40 (40 delta). Then, the delta increases by 3 due to the value of gamma (3). Finally, the value of gamma increases by 2, thanks to the speed variable. This inter-dependent calculation allows you to see how exponentially explosive and quick options can be; in just a 3% move, the price of the near-the-money option more than doubled.

So, knowing those mechanics, I figured that if the price of an asset is moving very quickly and strongly in one direction due to some recent event/information, you can put on a short-duration hedged trade in the opposite direction. This is equivalent to saying: “This information break seems significant and the market is currently reacting to it aggressively, I don’t know how long it’ll continue for or how much more aggressive it’ll get, but based on the respective event, the price probably won’t immediately revert with the same level of aggression, so I can collect a quick premium by accepting that risk.”

Let’s see what that looked like in practice: