Sunday, 20 May 2007

The short gamma of short gamma

Very roughly, a short gamma trading strategy is one that profits from not much happening and loses a lot of money if there are big moves, whereas a long gamma strategy loses a little money every day there isn't a big more, but makes a lot if there is.

Short gamma traders (in the widest sense) are trend followers or people who believe things will be normal. Long gamma traders want something unusual to happen.

Now here's the thing. At the moment there is a lot of talk about a market crash being imminent. For instance, Calculated Risk is doing a good job of recording the woes of the US housing market, Nassim Taleb's new book on long gamma has been getting a lot of publicity, and Anthony Bolton is predicting a crash. But if everyone is expecting a crash, surely this is the orthodoxy. And true long gamma traders pay to get a position that will profit if the orthodoxy does not prevail. So shouldn't they go short gamma? And vice versa of course.

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