gamma
The rate of change of an option's delta relative to changes in the underlying asset's price, measuring the curvature of the option's value.
Example
“High gamma near expiration means small stock moves can create large changes in the option's delta and value.”
Memory Tip
GAMMA = how fast delta changes. High gamma = option gets more sensitive to price moves quickly.
Why It Matters
Gamma helps traders understand how sensitive their option positions are to price movements and whether their hedges will remain effective as markets move. For options traders, managing gamma is crucial because it determines how much their delta exposure changes, which directly impacts their risk and potential profits or losses.
Common Misconception
Many people mistakenly believe that gamma only matters for complex traders and does not affect regular investors. In reality, anyone holding options needs to understand gamma because it shows how quickly the option's price sensitivity changes, which can lead to unexpected losses if market moves are larger than anticipated.
In Practice
Consider a call option on a stock trading at 100 dollars with a delta of 0.50 and a gamma of 0.05. If the stock price rises to 101 dollars, the delta does not stay at 0.50 but increases to approximately 0.55 due to the gamma effect. This means the option becomes more sensitive to further price increases, so a trader who was hedged at the original delta level now has unintended additional exposure to upward price movements.
Etymology
From Greek 'gamma', the third letter of the alphabet. The third derivative of option price, after delta.
Common Misspellings
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See Also
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