Gamma is often called the "second derivative" Greek because it measures how fast Delta changes. While Delta tells you the current sensitivity of your option to stock movement, Gamma tells you how that sensitivity will change as the stock moves. Understanding Gamma is crucial for managing options positions effectively.
What is Gamma?
Gamma measures the rate of change in Delta for every $1 move in the underlying stock. If an option has a Gamma of 0.05, the Delta will increase or decrease by 0.05 for every $1 the stock moves.
Think of it this way: Delta is your speed, and Gamma is your acceleration. A high Gamma means your Delta (speed) can change rapidly, which affects how quickly your profits or losses can accelerate.
How Gamma Works
Gamma is always positive for both calls and puts when you buy options. This means:
- For calls: As the stock goes up, Delta increases (good for call buyers)
- For calls: As the stock goes down, Delta decreases (limits losses)
- For puts: As the stock goes down, Delta becomes more negative (good for put buyers)
- For puts: As the stock goes up, Delta moves toward zero (limits losses)
Example: Gamma in Action
You buy a call option with Delta of 0.50 and Gamma of 0.05. The stock is at $100.
- Stock moves to $102 (+$2): New Delta = 0.50 + (2 x 0.05) = 0.60
- Stock moves to $105 (+$5): New Delta = 0.50 + (5 x 0.05) = 0.75
Notice how your Delta keeps increasing as the stock rises, meaning you capture more and more of each subsequent dollar move. This is the power of positive Gamma.
When is Gamma Highest?
Gamma is not uniform across all options. Several factors determine how much Gamma an option has:
1. Strike Price Proximity
At-the-money (ATM) options have the highest Gamma. Options that are deep in-the-money or far out-of-the-money have very low Gamma. This makes sense because ATM options have the most uncertainty about whether they will end up profitable.
2. Time to Expiration
Gamma increases dramatically as expiration approaches, especially for ATM options. This is why the last few days before expiration can see explosive moves in option prices. Traders call this period "Gamma week" or refer to the risk as "Gamma exposure."
3. Implied Volatility
Lower implied volatility leads to higher Gamma for ATM options. When volatility is low, the probability distribution of future stock prices is more concentrated, making ATM options more sensitive to movements.
Gamma Risk: The Double-Edged Sword
While positive Gamma benefits option buyers, it creates significant risk for option sellers. When you sell options, you have negative Gamma, which means:
- Losses accelerate as the stock moves against you
- Your Delta exposure keeps getting worse
- You may need to hedge more frequently
Example: Gamma Risk for Sellers
You sell a call option with Delta of -0.50 and Gamma of -0.05. The stock rallies from $100 to $105.
- Your Delta becomes: -0.50 - (5 x 0.05) = -0.75
- You went from being -50 Delta to -75 Delta
- Each additional $1 move now costs you $0.75 instead of $0.50
This is why experienced traders say that selling options near expiration is risky - Gamma can cause rapid, unpredictable losses.
Gamma and Position Management
Understanding Gamma helps you manage positions more effectively:
For Option Buyers
- High Gamma means quick profits when right, but also rapid time decay (Theta)
- ATM options give you the most Gamma exposure
- Consider the Gamma-to-Theta ratio to find optimal entry points
For Option Sellers
- Avoid selling ATM options near expiration (highest Gamma risk)
- Wider spreads reduce Gamma exposure
- Consider closing positions before the final week of expiration
Pro tip: Many professional traders calculate their total portfolio Gamma to understand how much their overall Delta will change with a 1% market move. This helps them prepare for various scenarios and hedge accordingly.
Gamma Scalping: A Trading Strategy
Some traders use Gamma to their advantage through a strategy called Gamma scalping. The basic idea is to:
- Buy ATM options (positive Gamma position)
- Hedge Delta to zero by trading the underlying stock
- As the stock moves, Delta changes (due to Gamma)
- Re-hedge by buying or selling stock to return to Delta neutral
- The profit comes from "scalping" the stock movements while Theta decay is the cost
This strategy profits from actual volatility exceeding implied volatility. Learn more in our complete guide to Gamma scalping.
Gamma Exposure (GEX) in Market Analysis
Institutional traders and market analysts track aggregate Gamma exposure (GEX) to predict market behavior. When dealers are short Gamma (negative GEX), they must buy when stocks rise and sell when stocks fall, amplifying moves. When dealers are long Gamma (positive GEX), the opposite occurs and markets tend to be more stable.
Common Gamma Mistakes
- Ignoring Gamma near expiration: The last week before expiration has explosive Gamma, leading to unexpected large moves.
- Selling ATM options without understanding Gamma risk: This can lead to rapidly accelerating losses.
- Not considering Gamma in spreads: Spread positions have net Gamma that differs from individual legs.
- Confusing Gamma direction: Remember, buyers have positive Gamma (good), sellers have negative Gamma (risky).
Monitor Your Gamma Exposure
Pro Trader Dashboard displays Gamma for all your options positions, helping you understand your risk profile and make better trading decisions. See how your Delta changes with market moves.
Summary
Gamma is the accelerator pedal of options trading. It tells you how fast your Delta will change and helps you understand the non-linear nature of options. For buyers, positive Gamma is an advantage. For sellers, negative Gamma is a risk that must be managed carefully, especially near expiration.
Continue your Greeks education with our guides on Delta, Theta, and Vega.