Gamma

So far we've discussed Delta and Theta.  Gamma is next on the list.  Gamma, simply stated, is the rate at which an option's Delta changes as the price of the underlying (stock, index, ETF) changes.  Normally, the data provider on any given software package will express Gamma as the Delta's gained or lost for each one point/dollar change in the underlying.

The Delta will increase the amount of the Gamma when the underlying goes up and will fall the amount of the Gamma when the underlying goes down.  If, for example, the $50 strike Call has a  Gamma of .02 then for each point rise (fall) in the price of the underlying, the option will gain (lose) 0.02 Deltas.  If the original Delta was 0.30 and the underlying moves up (down) one full point, then the new delta of the option will be 0.32 (0.28).


Gammas are always represented as positive numbers regardless of whether they are associated with a Call or Put.  If we are working with either Calls or Puts we will always add the Gamma to the old Delta as the underlying rises, and subtact the Gamma from the old Delta as the underlying falls.  When a trader is long in his option positions, whether Calls or Puts, he/she has a long Gamma position.  When he/she is short options, he/she has a short Gamma position.


The Gamma has important risk characteristics that must be examined.  If the Gamma is a large number, whether positive or negative, it indicates a high degree of risk.  If the Gamma is a small number, whether positive or negative, it indicates a low degree of risk.


While there are volumes written on the subject of Gamma, we've discussed here enough to think about and establish a basic understanding of Gamma.