Analysing gamma and theta: assessing risk and reward in options trading
Options trading is considered an advanced form of investing because it’s highly leveraged and involves taking on additional risk compared to stocks, bonds, or other asset classes. Options contracts in Singapore give investors the right to trade a stock without obligation at a predetermined price. As such, they provide potential benefits like portfolio diversification and hedging existing positions. However, the added leverage also carries more significant risks that any investor should carefully manage. To manage the risk effectively, it’s essential to understand two key concepts: gamma and theta, associated with options trading.
What is gamma?
Gamma measures how delta (the rate of change in option values) changes when share prices increase or decrease. While delta is a static number that expresses the possibility of an option expiring in the money, gamma measures how quickly this probability can change as share prices move. Essentially, it’s the rate at which the delta changes concerning movements in share price.
Gamma is always positive and increases whenever the underlying stock moves higher or lower, which means investors with extended options will benefit from more significant moves in share prices than those with short options because their positions have more gamma exposure (i.e., they will benefit more).
What is theta?
Theta measures the value an option loses over time due to the passing of time rather than changes in the stock price. It is always negative and decreases as the expiration date approaches, regardless of what happens to share prices.
Theta represents a significant risk for investors because it can erode the value of their position over time, even if share prices remain unchanged. Experienced traders will look to adjust their positions or close them out before expiration to reduce this risk.
Understanding gamma and theta can help options traders assess risk and reward potential more accurately. By better understanding these concepts, investors can make more informed decisions when trading options contracts. Moreover, they could also use gamma and theta to structure trades that could increase their returns while reducing their downside exposure.
Other strategies used by options traders in Singapore
Options traders in Singapore employ various strategies to maximise their returns and reduce their risks.
The straddle strategy
One popular strategy is the straddle strategy, which involves buying both calls and put options with the same strike price and expiration date. This strategy allows traders to benefit from rising and falling share prices as long as they can accurately predict the underlying asset’s direction.
The covered call strategy
Another common options trading strategy is the covered call, which involves buying a stock and selling a call option on that same stock simultaneously. By doing this, traders can generate additional income from holding onto their stocks while limiting their downside risk if the stock’s value declines.
The gamma scalping strategy
A third popular option trading strategy is known as gamma scalping. In this technique, traders will take advantage of gamma exposure by opening and closing positions quickly over short periods to make small profits on significant price movements during highly volatile markets. This approach requires a high degree of technical analysis skills to be successful.
The option spread strategy
Some options traders in Singapore use option spread strategies, which involve taking positions in two or more options contracts with different strike prices and expiration dates to offset some of the risk associated with each contract. By combining different types of contracts (i.e., calls, puts, straddles), investors can create positions with limited downside risk while having the potential for higher rewards than any contract alone would provide.
Novice traders should consider using an experienced broker when trading options in Singapore. Depending on individual risk profiles, professional brokers can provide valuable advice and guidance on the most suitable strategies. They may also help traders better understand gamma and theta and other options trading concepts such as implied volatility, leverage, and time value decay. Learn more about brokers in Singapore at home.saxo.
Analysing gamma and theta is integral to successful options trading in Singapore. By understanding how they work, investors can assess risk and reward potential more accurately, helping them structure their positions to maximise returns while minimising risks. Utilising experienced brokers who specialise in options trading can be beneficial for novice traders who are just starting. With the right advice and guidance, traders in Singapore can enjoy a potentially profitable options trading journey.