What is Gamma in Options Trading

In options trading, it’s essential to grasp how various factors influence price movements. Among the key sensitivity indicators known as the Greeks, Gamma plays a particularly important role. While Delta shows how much the option premium moves in response to a ₹1 fluctuation in the underlying asset’s price, Gamma measures how rapidly Delta itself shifts. This characteristic makes Gamma a crucial component in managing positions, especially in strategies involving multiple or high-volume options. Let’s dive into what Gamma means, how it operates, and why it matters for informed trading decisions.

Gamma is one of the key metrics, known as the “Greeks,” used in options trading to assess risk and price sensitivity. Specifically, Gamma indicates how much an option’s Delta is expected to change when the price of the underlying asset moves.

• Delta measures the first level of sensitivity: how much an option's price changes as the underlying moves.
  

• Gamma measures the second level of sensitivity: how much Delta changes as the underlying price moves.

Gamma is one of the key metrics, known as the “Greeks,” used in options trading to assess risk and price sensitivity. Specifically, Gamma indicates how much an option’s Delta is expected to change when the price of the underlying asset moves.

• Delta measures the first level of sensitivity: how much an option's price changes as the underlying moves.
  

• Gamma measures the second level of sensitivity: how much Delta changes as the underlying price moves.

Example to understand Gamma in options trading

Suppose you hold a call option with a delta of 0.5 and a gamma of 0.1. If the stock price rises by ₹1, the delta will increase from 0.5 to 0.6 due to gamma. This means your option becomes more sensitive to price changes, increasing its value faster. Gamma helps traders understand how quickly delta changes, especially useful in managing risk for large price moves.

A “good” gamma depends on your trading strategy. Higher gamma is preferred by short-term traders as it means delta changes quickly, offering higher profit potential but with greater risk. Lower gamma suits long-term investors seeking stable delta and lower volatility in option value.

High Gamma: Seen in near-the-money, near-expiry options; indicates greater sensitivity to price changes—higher risk and reward.

Low Gamma: Found in deep in-the-money or far out-of-the-money options, and long-dated options; indicates slower delta change and lower risk.

Gamma measures the rate of change of delta in an option relative to changes in the underlying asset’s price. It helps traders understand how sensitive delta is, especially for near-the-money options. Gamma is highest when options are close to expiry and near the strike price, making it crucial for managing rapid shifts in risk exposure.

Improved Risk Management: Helps predict how quickly delta will change, aiding in hedging strategies.

Precision in Positioning: Assists in adjusting trades for market moves, especially in volatile conditions.

Enhanced Profit Potential: High gamma offers opportunities for quick gains in fast-moving markets.

Informed Strategy Selection: Helps traders choose the right options based on time to expiry and price proximity.

Gamma behaves differently based on where the option sits relative to the strike price:

• Options that are at-the-money (ATM) tend to exhibit the most sensitivity in their Delta changes, making them associated with the highest Gamma values.
  

• Options that are either in-the-money (ITM) or out-of-the-money (OTM) generally show lower Gamma, as their Delta shifts are less responsive to minor price movements in the underlying asset.
  

This is because ATM options are most sensitive to movements in the underlying asset.

Traders who delta-hedge their positions also watch Gamma closely. If Gamma is high, maintaining a neutral Delta position becomes more difficult and requires frequent rebalancing. This is particularly relevant for institutions or advanced traders managing large portfolios.

Gamma Scalping

Some traders use Gamma scalping, a strategy that involves buying options with high Gamma and trading the underlying to profit from market swings. However, this method can be complex and costly due to frequent adjustments and transaction fees.

Gamma increases as an option approaches expiry, particularly for ATM options. This means traders need to be more cautious when holding positions close to expiration, as even small moves in the underlying can lead to significant changes in Delta.

Gamma is a double-edged sword:

• High Gamma = high sensitivity = potential high reward or high risk.
  

• Low Gamma = more stable Delta = predictable price movements.

Options sellers (especially of ATM options) are usually more exposed to Gamma risk.

Gamma is a critical component of options trading that reflects how Delta changes as the market moves. Understanding it can help traders manage risk, refine hedging strategies, and anticipate market sensitivity better. While it’s a more advanced concept, even beginners should start familiarising themselves with Gamma if they plan to trade options effectively.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.