Option Gamma measures the rate of change of an option's delta relative to changes in the underlying asset's price.
Option Gamma is a key Greek metric in options trading that quantifies the sensitivity of an option's delta — the first derivative of the option's price with respect to the underlying asset's price — to movements in the underlying asset. In simpler terms, while Delta indicates how much the option price changes for a small move in the underlying, Gamma shows how quickly this Delta changes as the price of the underlying asset moves. A higher Gamma means the Delta is more sensitive to price movements, which results in larger shifts in option price for changes in the underlying asset. In the context of finance and wealth management, especially for portfolios that include options, understanding Gamma is crucial for managing the risks related to changes in the underlying asset's price. Option traders use Gamma to dynamically hedge their positions to maintain a targeted exposure, a process called gamma hedging. Gamma is highest for at-the-money options approaching expiration, making the option’s price highly responsive to underlying price changes as it gets closer to expiration. Option Gamma is an essential part of risk management in derivative strategies, serving to anticipate how an option’s Delta will evolve, which impacts decisions on rebalancing hedges and assessing the risk profile of option portfolios. It complements other sensitivity measures such as Delta, Theta, and Vega, providing a deeper understanding of option price dynamics.
Gamma's role in option sensitivity makes it important for developing effective risk and investment strategies involving derivative securities. High Gamma indicates that small changes in the underlying can cause significant changes in the option's Delta, exposing portfolios to increased directional risk. This necessitates active monitoring and potentially frequent adjustments (rehedging) to maintain the desired risk profile. In wealth management and family offices, harnessing Gamma can contribute to tactical advantage by managing the convexity of option exposures, optimizing risk-return tradeoffs. For fixed-income and equity derivatives within a portfolio, understanding Gamma assists in gauging how option positions might behave in volatile markets, supporting both reporting accuracy and tax planning through precise valuation. Moreover, Gamma helps in structuring option strategies that seek downside protection or leverage upside potential, which are vital governance concerns when overseeing complex portfolios.
Consider a call option with a Delta of 0.5 and a Gamma of 0.1 at an underlying price of $100. If the underlying rises by $1 to $101, the Delta will increase by Gamma's amount (0.1), making the new Delta 0.6. This means the option’s price sensitivity to the underlying has increased, and for the next $1 increase in underlying price, the option price will change by approximately $0.6 instead of $0.5. This illustrates how Gamma affects the responsiveness of Delta to underlying price movements.
Option Delta
Option Delta measures the sensitivity of an option's price to a one-unit change in the price of the underlying asset. While Delta captures the directional exposure, Gamma measures how this exposure changes as the underlying price moves, making them complementary metrics for managing option risk.
What does a high Gamma mean for an option position?
High Gamma means the Delta of the option changes rapidly with small movements in the underlying asset price, increasing the sensitivity and potential volatility of the option’s price. This usually occurs near the option’s expiration and at-the-money strike prices.
How is Gamma different from Delta in options trading?
Delta measures how much the option’s price changes with a small move in the underlying asset, while Gamma measures how much the Delta itself changes as the underlying price changes. Gamma provides insight into the acceleration of Delta, important for managing risk dynamically.
Why is Gamma important for hedging option positions?
Gamma is crucial because it indicates how often and by how much an investor needs to adjust (rehedge) their Delta hedges as the underlying price moves. Managing Gamma helps in maintaining a stable risk profile and prevents unexpected losses due to shifts in Delta.
