Delta , Vega and Theta generally get most of the attention, but Gamma has important implications for risk in options strategies that can easily be demonstrated. First, though, let's quickly review what Gamma represents.

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As was presented in summary form in Part II of this tutorial, Gamma measures the rate of change of Delta. Delta tells us how much an option price will change given a one-point move of the underlying. But since Delta is not fixed and will increase or decrease at different rates, it needs its own measure, which is Gamma.

Delta, recall, is a measure of directional risk faced by any option strategy. When you incorporate a Gamma risk analysis into your trading, however, you learn that two Delta s of equal size may not be equal in outcome.

The Delta with the higher Gamma will have a higher risk and potential reward, of course because given an unfavorable move of the underlying, the Delta with the higher Gamma will exhibit a larger adverse change. Figure 9 reveals that the highest Gamma s are always found on at-the-money options, with the January call showing a Gamma of 5.

The same can be seen for the puts. For more insight, see Gamma-Delta Neutral Option Spreads. IBM options Gamma values. Values taken on Dec. The highest Gamma values are always found on the at-the-money options that are nearest to expiration. OptionsVue 5 Options Analysis Software In terms of position Gamma , a seller of put options would face a negative Gamma all selling strategies have negative Gamma s and buyer of puts would acquire a positive Gamma all buying strategies have positive Gammas.

But all Gamma values are positive because the values change in the same direction as Delta i. Signs change with positions or strategies because higher Gammas mean greater potential loss for sellers and, for buyers, greater potential gain. Gammas along a strike chain reveal how the Gamma values change.

Take a look at Figure 9, which again contains an IBM options Gamma matrix for the months of January, February, April and July. If we take the out-of-the-money calls indicated with arrows , you can see that the Gamma rises from 0. IBM options Delta values. OptionVue 5 Options Analysis Software. Finally, when looking at Gamma values for popular strategies, categorization, much like with position Theta , is easy to do.

All net selling strategies will have negative position Gamma and net buying strategies will have net positive Gamma. For example, a short call seller would face negative position Gamma. Clearly, the highest risk for the call seller would be at-the-money, where Gamma is highest. Delta will increase rapidly with an adverse move and with it unrealized losses. For the buyer of the call, it is where potential unrealized gains are highest for a favorable move of the underlying.

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Gamma Risk and Reward By John Summa Share. Options and Risk Parameters Options Greeks: Delta Risk and Reward Options Greeks: Vega Risk and Reward Options Greeks: Theta Risk and Reward Options Greeks: Gamma Risk and Reward Options Greeks: Position Greeks Options Greeks: Inter-Greeks Behavior Options Greeks: OptionVue 5 Options Analysis Software Figure IBM Options Gamma values.

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OptionVue 5 Options Analysis Software Perhaps more interesting, however, is what happens to Delta and Gamma values across time when the options are out-of-the-money.

Looking at the strikes, you can see in Figure 11 that the Gamma s rise from 1. While lower levels than for the at-the-money call options again always the highest Gamma strike whether puts or calls , they are associated with falling, not rising Delta values, as seen in Figure While not circled, the calls show Delta s for July at This tells us that the while out-of-the-money January calls have gained Gamma , they have lost significant Delta traction from time value decay Theta.

What do the Gamma values represent? A Gamma of 5. Looking at the Delta for the January puts in Figure 10 for a moment, which is To verify this, take a look at the Delta value for the at-the-money strikes five points higher. What accounts for the difference? Another measure of risk is known as the Gamma of the Gamma. Note that Gamma is increasing as the put moves closer to being at-the-money.

If we take an average of the two Gamma s and strike Gamma s , then we will get a closer match in our calculation. For example, the average Gamma of the two strikes is 4.

Using this average number, when multiplied by 5 points, gives us Strategies Position Gamma Signs Long Call Positive Short Call Negative Long Put Positive Short Put Negative Long Straddle Positive Short Straddle Negative Long Strangle Positive Short Strangle Negative Put Credit Spread Negative Put Debit Spread Positive Call Credit Spread Negative Call Debit Spread Positive Call Ratio Spread Negative Put Ratio Spread Negative Put Back Spread Positive Call Back Spread Positive Calendar Spread Positive Covered Call Write Positive Covered Put Write Positive Figure Position Gamma signs for common strategies for options.

The position Gamma s in this table represent standard strategy setups. Conclusion Gamma tells us how fast Delta changes when the underlying moves, but it has characteristics that are not so obvious across time and vertically along strike chains for different months.

Finally, position Gamma s for popular strategies is presented in table format.

Find the middle ground between conservative and high-risk option strategies. These risk-exposure measurements help traders detect how sensitive a specific trade is to price, volatility and time decay. Learn more about the position delta hedge ratio and how it can tell you the number of contracts needed to hedge a position in the underlying asset.

There are ways to control risks, reduce losses and increase the likelihood of success in your portfolio. Find out how spreads can help. You may participate in both a b and a k plan.

Gamma

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