Hybrid Vigor: Vol 2 Issue 12 "Phi Slamma Gamma"

Dear Friends

It’s great to see all those “I Still Hate Christian Laettner” shirts.  Being a huge fan of horse racing makes me something of an automatic Kentucky fan, so I, like many, still feel wounded by that shot.  Anyway, it was a great weekend, though my pride in picking Michigan State over Virginia took a fall in the Battle of Evermore—I mean Kansas.

It was watching the game of Laettner’s fabled shot that first suggested to me the analogy of basketball and option Greeks—specifically, that a great way to understand gamma is to think about a game that’s tied or nearly tied with very little time remaining.  Think of a team’s delta as its chance of finishing in the money (i.e. winning the game).  Radical swings in the team’s delta (based on a small move, i.e., a single basket) cannot happen early in the game under any circumstances. For example, Hampton led Kentucky, 4-3, for a few seconds last week. Did that score have Vegas oddsmakers recalculating? No, Kentucky’s delta was still 99-something. No gamma there.

But when games go down to the wire, each score could be the difference-maker.  When a team is down two points with just a matter of seconds left, and doesn’t have the ball, its delta is pretty low. If it then manages to get the ball and hit a three-pointer, its delta swings from say 10% to 90%, or thereabouts. That’s serious gamma.

It’s important to remember this when you’re tempted to get caught up in thinking of a short-dated convertible as an automatic gamma play. A friend recently complained to me that too many convertible wannabes talk about the high gamma in 20-delta bonds just because they only have a year to maturity.  Remember, you need to be very near both the conversion price and the expiration to have big gamma.

We haven’t commented on the situation, but we read with interest about the MGM 4.25% bond, whose delta went from 65% to 95% in a single trading session. Now that’s gamma—almost Laettneresque. 

And yes—my favorite team is still whoever is playing Duke.


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