How do I size a liquidity buffer for a strategy that is short gamma and short vega?

Question

AcadiFi · Accepted Answer

Sizing the buffer starts with stress scenarios, not average-day assumptions. A short gamma and short vega strategy can lose from gap risk, implied-volatility expansion, and rising margin requirements at the same time. The liquidity buffer has to be large enough to survive a stressed path, not just a typical daily fluctuation.

Suppose Granite Options Income runs a position that looks stable most days but is vulnerable to a sharp overnight move and a volatility spike. The desk should stress the portfolio for multi-sigma price gaps, widened spreads, and exchange margin calls, then estimate how much cash is needed to keep positions intact without forced liquidation. That amount is the starting point for the liquidity buffer.

```mermaid
flowchart TD
  A[Short gamma and short vega position] --> B[Stress price gap]
  A --> C[Stress vol expansion]
  B --> D[Margin call estimate]
  C --> D
  D --> E[Required liquidity buffer]
```

The FRM logic is that funding liquidity and market liquidity interact. If you size the buffer only from expected P/L, you miss the path where losses and margin calls arrive before positions can be adjusted. Good risk management asks, "How much cash keeps us alive through the ugly path?" Practice more in our FRM question bank.

How do I size a liquidity buffer for a strategy that is short gamma and short vega?

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