How to Play Pickle With the Market, Using the Greeks

 | Jun 19, 2017 | 9:00 AM EDT
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Remember as a kid playing pickle? This is the game where say on a baseball field you are in a rundown between two bases, and players on the other team are trying to tag you out. You run back and forth, dodge, duck and swerve to avoid a tag and make it safely to one of two bases. It's a thrilling, zero sum game, often filled with surprising moves.

There are market trading strategies that are similar to the game of pickle, in which we do our best to stay away from the tag that puts us out of the game. Some out there are riskier than others. The short gamma trade has been a winner, mostly due to extended low volatility (more on that later). Using a high probability approach with low risk offers a chance to not only stay in the game, but to win far more often, even if the rewards are small.

With the market still holding on to low volatility, we often see little movement in markets on some days. That is a function of the VIX, or volatility index. It is when market volatility is low that the expectation is for market movements to be extremely thin. Now, that doesn't mean some stocks under the surface won't move; it simply means the market as a whole has low probability of big moves to come. Note probability, not certainty!

As an option player, I need to be aware of components that will drive prices in certain conditions. Two of these are so-called Greeks (because their names have been picked from the Greek alphabet), called delta and gamma. They are both related. In fact, gamma is a derivative of the delta, which is simply the amount an option will move with a $1 move in the underlying (in most cases, a stock). This delta moves constantly with time and the price of the underlying.

Gamma is the rate of change of the delta's move. It is either positive or zero. The key here is to identify a strong rate of change up or down in gamma, depending on our position.

If gamma is retreating, it means the amount by which the delta will move is shrinking -- a delight for those who are short options. Conversely, long option holders despise the shrinking gamma, which is a solid bet when volatility is low or declining.

Some make a living selling deltas and shorting gamma. While the current condition seems ripe for that strategy, there are times when it becomes difficult -- and perhaps a major wipeout is just around the corner.

We'll explore the mechanics and see a real life trade and how it came to be fixed by using technicals and charts in a next installment.

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