Gamma-Theta Tradeoff and Compensation

Since people interested in working in the low-latency trading industry often apply to multiple opportunities, they often receive offers from multiple companies. If you are fortunate enough to find yourself in this situation, you now have a tough decision to make: which job offer do you take? Which company do you choose, and how do you decide?

There is a concept in mathematical finance, specifically options theory, that might help with this decision.

Options have a property called gamma, which is the second derivative of the option’s price with respect to the price of its underlying. We don’t need to get into exactly what that means here, but suffice to say that gamma is a good thing. It lets you make more money as you make money and lose less money as you lose money.

You have probably encountered gamma in your everyday life. When you buy car insurance, for instance, you are buying gamma. With this particular type of gamma, you pay less for repairs after an accident. Similarly, when you buy a Costco membership, you are buying gamma, since you pay less with a membership for a same quantity purchase than you otherwise would.

In fact, perhaps gamma can explain why, in many cases, the rich get richer. Some of these wealthy people own gamma – the fact that they already have wealth gives them financial opportunities unavailable to those without. Perhaps a similar line of reasoning can explain why the poor, so to speak, often remain poor.

Gamma is not free. In options theory, the price of gamma is theta, otherwise known as time decay. In our previous analogies, if gamma is your car insurance policy, then theta is your monthly payment. And, if gamma is your Costco membership, then theta is your annual fee.

Theta is worth mentioning, because typically the more gamma you get, the more theta you pay. This observation, also known as the gamma-theta tradeoff, is the options theory version of the “no free lunch” theorem. Indeed, at least in the case of car insurance, high-risk drivers tend to pay higher rates.

The gamma-theta tradeoff is relevant to compensation. People at large companies typically have little to no gamma, but are collecting decent theta – they have little to no opportunities to grow with the company, but have decent salaries. In contrast, people at small companies have a lot of gamma, but are collecting less theta – they have a lot of opportunities to grow with the company, but have lower salaries.

So, the next time you are deciding among job offers from multiple companies, all else equal, consider asking yourself: “What do I value more, gamma or theta?” The answer might surprise you.