Got a Handle on Your Gamma?

BY LICIA LESLIE

April 14, 2024

Hi Shoppers,

We last talked about an option’s delta.

You know, the option “Greek” that shows the anticipated change in the option price for a $1 move in the underlying. Also thought of as a hedge ratio for the option, or the percentage chance the option will finish in the money if the volatility stays constant.

So what is gamma?

According to the Option Pit Glossary gamma is the rate of change of an option’s delta for every $1 move in the underlying.

The gamma of an option tells you how much your delta will move per one dollar move in the stock.

Buying options gives you positive gamma and selling options gives you negative gamma.

Now, if you’ve been following me at all, you know I prefer buying options with the highest gamma.

The options that carry the highest gamma are the at the money options with less time until expiration.

Gamma is a powerful tool when selecting which options you want to buy to enter a long or short delta position in a stock.

You want to purchase the option that is going to make the most money once the stock moves in your direction.

That will be the option with the highest gamma.

When carrying a position that has several different options, the gamma of the overall position will give you the amount of deltas you are gaining or losing as the stock moves up and down.

This tells you the amount of deltas you need to buy or sell per dollar move in your stock.

For example, if you have a positive 100 gamma, you will gain 100 deltas as the stock moves up one dollar.

To stay delta neutral at that new stock price, you need to sell those 100 deltas.

Same for the downside, only you would be short 100 deltas and need to buy them in to stay delta neutral.

Being short gamma is a bit trickier to manage because you will need to buy in the deltas as the stock moves higher and sell deltas as the stock moves lower.

Being long gamma you want your stock to move.

As you buy and sell those deltas up and down, you are scalping and making money.

Holding a short gamma position you want your stock to sit at one price while you collect the decay of the options you are short.

Of course this is holding all the other factors constant and we all know, that never happens in options.

Thanks for Reading … See You Next Tuesday,

Licia Leslie