What Is Gamma?

What Is Gamma?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Gamma is a term used in finance and is associated with derivative products such as options. It’s one of the ‘Greeks’ that traders use to assess risks when trading these instruments. Gamma refers specifically to the rate at which the Delta of an option will change after a $1 move in the underlying asset (like a stock). Essentially, it’s a measure of how fast the price of an option is expected to change when the price of the asset it’s tied to changes. This can affect the profitability of certain trading strategies.

Related Questions

1. How does Gamma impact my trading strategies?

Gamma impacts your trading strategy by predicting how much the price of your option will change when the price of the underlying asset changes. If you are holding options and the underlying asset makes a move in the direction you’re betting on, a high gamma means the price of the option will increase faster, potentially leading to higher profits.

2. Why are Gamma and Delta related?

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Gamma and Delta are related because Gamma is essentially the derivative of Delta. It’s the rate at which Delta will change with a $1 change in the price of the underlying asset. Delta is about how much the option’s price changes per $1 move in the asset, while Gamma is the acceleration of that change.

3. Are Gamma values always negative?

Not necessarily. While the Gamma of put options is usually negative, the Gamma of call options is generally positive. This happens because the Delta of a call option increases as the underlying asset’s price rises, while the reverse happens for put options.

4. How can I manage Gamma risk?

Gamma risk, or the risk of changes in the underlying asset’s price that could affect the profitability of an options strategy, can be managed through hedging techniques. This could involve buying or selling options to offset the Gamma of your existing positions.

5. What is the relationship between Gamma and Vega?

Vega measures how an option’s price changes with volatility. But, like Gamma, it doesn’t remain constant and adjusts as the markets move. When the volatility (Vega) is high, Gamma tends to be lower because rapid price changes can make it more likely for the market to swing beyond the favorable price range for the option.