The Bucking Gamma Bull

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Our preference for most positions is to close out short legs with strikes that are near-the-money before the dynamics of expiration week have a chance to kick in. While it's true that theta declines more quickly as expiration looms, tempting option shorts to hold on as long as possible, it is also true that gamma rises more quickly closer to expiration, as shown below.

Call Gamma vs. Time to Expiration and Initial Price

Source: Condor Options

View Chart »

There is no one right answer about how to trade expiration. But if we are short some strikes that have already given up a lot of their premium, we usually prefer to buy back those shorts before the negative gamma has a chance to build up enough to wrestle control away from us.

It's a simple question of risk management. Assuming you're long theta / short gamma in any size, you'll be hedging your deltas within some tolerable range. But the larger your gamma exposure, the more your deltas will change as the underlying moves around, and as gamma exposure grows toward the end of an expiration cycle, it can become increasingly difficult and impractical to hedge that directional risk.

Think of your deltas as a mechanical bull, and your gammas as the rate and intensity at which the bull throws you around. The ride starts off quietly, but as time goes on the bull gets increasingly difficult to ride, and eventually you're likely to be thrown. That's exactly what happens during an expiration week in which the underlying makes an unexpected move: option shorts can't control their directional risk as easily as they'd like and have to hedge more deltas to stay on the ride, which only feeds the existing move in the underlying, which -- because of all that negative gamma -- forces options shorts to hedge even more deltas and so on into a downward spiral of flailing limbs, bruises, and spilled beer.

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