Gamma is often called the most dangerous Greek in options trading. While delta tells you your directional exposure right now, gamma tells you how fast that exposure will change. Understanding and managing gamma risk is essential for any serious options trader. In this guide, we will explain what gamma is, why it matters, and how to manage gamma risk in your portfolio.
What is Gamma?
Gamma measures the rate of change in delta for every $1 move in the underlying stock. Think of delta as your speed and gamma as your acceleration. If you have high gamma, your delta (and therefore your risk) can change very quickly.
The simple version: Gamma tells you how unstable your position is. High gamma means your position can swing from profitable to unprofitable very fast as the stock moves.
Understanding Gamma Values
Here is what you need to know about gamma:
- Long options: Always have positive gamma. You benefit when the stock makes big moves
- Short options: Always have negative gamma. You are hurt when the stock makes big moves
- At-the-money options: Have the highest gamma
- Deep in-the-money or out-of-the-money options: Have low gamma
Why Gamma is Dangerous
Gamma becomes particularly dangerous in these situations:
Example: Short Gamma Near Expiration
You sold a 100 strike call expiring tomorrow. The stock is at $99.50.
- Current delta: -0.45 (you are short 45 shares equivalent per contract)
- Gamma: 0.50 (extremely high because it is at-the-money near expiration)
- Stock moves to $101: Delta jumps to -0.95
- You suddenly went from short 45 delta to short 95 delta
- This means you lost an extra $50 per contract on that $1.50 move
When Gamma Risk is Highest
Pay special attention to gamma in these scenarios:
- Expiration week: Gamma explodes for at-the-money options as expiration approaches
- Pin risk: When the stock is near a major strike price at expiration
- Concentrated strikes: When you have large positions at a single strike
- Volatile markets: Large moves expose gamma risk quickly
Long Gamma vs Short Gamma
Understanding the difference is crucial for managing your risk:
Long Gamma (Positive Gamma)
- You want the stock to move in either direction
- As the stock rises, your delta becomes more positive (you make more on the way up)
- As the stock falls, your delta becomes more negative (you make more on the way down)
- Time decay (theta) works against you
- Best environment: high volatility, large stock movements
Short Gamma (Negative Gamma)
- You want the stock to stay still
- As the stock rises, your delta becomes more negative (you lose more)
- As the stock falls, your delta becomes more positive (you lose more)
- Time decay (theta) works in your favor
- Best environment: low volatility, range-bound markets
Gamma Risk Management Strategies
Here are proven methods to manage gamma risk:
1. Close Positions Before Expiration
The simplest way to avoid gamma risk is to close short options positions before expiration week. Most professional traders close or roll positions with 5-7 days to expiration.
2. Spread Your Expiration Dates
Instead of concentrating positions in one expiration, spread them across multiple dates. This reduces the gamma spike you face at any single expiration.
3. Use Spreads Instead of Naked Options
Selling spreads instead of naked options caps your gamma exposure. The long leg of the spread offsets some of the gamma from the short leg.
Example: Spread Reduces Gamma
Naked short call at 100 strike: Gamma = -0.05
Call credit spread (short 100, long 105): Gamma = -0.02
The spread has less than half the gamma risk of the naked position.
4. Delta Hedge Frequently
If you must hold high gamma positions, hedge your delta more frequently. This locks in gains from favorable moves and limits losses from adverse moves.
5. Set Gamma Limits
Professional traders set limits on total portfolio gamma. A common rule is to keep gamma-at-risk (gamma times expected move) below a certain dollar amount.
Gamma Scalping Strategy
Gamma scalping is a technique used by long gamma traders to profit from stock movements while managing theta decay:
- Buy options to establish a long gamma position
- Delta hedge by selling stock when the stock rises
- Buy stock back when the stock falls
- Profit from the difference between buy and sell prices
- Repeat as long as the stock keeps moving
The catch: You need the stock to move enough to generate scalping profits that exceed your theta decay. If the stock sits still, you lose money every day.
Calculating Your Gamma Risk
To understand your gamma exposure, calculate these metrics:
- Total portfolio gamma: Sum of gamma across all positions
- Dollar gamma: Gamma multiplied by position size and stock price
- Gamma per 1% move: How much your delta changes if the stock moves 1%
Example: Calculating Dollar Gamma
You are short 10 contracts of ATM calls on a $100 stock. Gamma = 0.03.
- Total gamma: -0.03 x 10 x 100 = -30
- This means for every $1 move, your delta changes by 30
- If stock moves $5, your delta changes by 150
- At $100 stock price, that is $15,000 of additional exposure
Gamma and Market Makers
Understanding how market makers manage gamma can help you:
- When market makers are short gamma, they must buy as the market rises and sell as it falls
- This can accelerate moves and create "gamma squeezes"
- When market makers are long gamma, they do the opposite, which dampens moves
- Large open interest at certain strikes creates "gamma walls" that can act as support or resistance
Tools for Managing Gamma
Effective gamma management requires:
- Real-time gamma calculations: Know your exposure at all times
- Position-level breakdown: See which positions contribute most to gamma
- Expiration grouping: View gamma by expiration date
- Stress testing: See how gamma affects you at different stock prices
Monitor Your Gamma Exposure in Real-Time
Pro Trader Dashboard calculates your total portfolio gamma and shows you which positions have the highest gamma risk. Get alerts before expiration when gamma spikes.
Summary
Gamma is the Greek that catches traders off guard. While delta tells you your current exposure, gamma reveals how fast that exposure can change. Short gamma positions are particularly dangerous near expiration when gamma spikes. Manage your gamma risk by closing positions before expiration, using spreads, setting limits, and monitoring your total exposure. The traders who respect gamma are the ones who survive in the options market.
Continue learning about options Greeks with our guides on delta hedging, theta decay strategies, and vega trading.