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Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here. |
Options gamma is one of the Greeks used to measure the sensitivity of an option's price to changes in the underlying asset's price.
Specifically, gamma represents the rate of change in an option's delta for a $1 move in the underlying stock or index.
Some key points about gamma:
- Gamma indicates how quickly the option's delta will change as the underlying price moves. High gamma means delta will change rapidly.
- Gamma is highest for at-the-money options and decreases as options become in-the-money or out-of-the-money.
- Long options have positive gamma, while short options have negative gamma.
- Positive gamma benefits from rising volatility in the underlying, while negative gamma benefits from falling volatility.
- Gamma increases as expiration approaches due to the higher convexity of options pricing models.
The effect of gamma is that it impacts the rate at which an option hedger must re-hedge their delta risk as the underlying moves. High gamma necessitates more frequent delta hedging adjustments.
For example, if a call option has a delta of 0.50 and a gamma of 0.10, a $1 rise in the underlying would increase the delta to 0.60 (0.50 + 0.10).
Market makers and traders are exposed to gamma risk, which can lead to quick profits or losses depending on the direction of the underlying move.
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