1. What is Gamma?
Gamma is one of the “Greeks” used in options trading, representing the rate of change in an option’s Delta for each one point change in the price of the underlying asset. In other words, Gamma measures the acceleration of an option’s price movement. It’s particularly important for options traders who engage in strategies that involve buying options, as these strategies can benefit from a rapid increase in the option’s price.
2. The Effect of Price on Gamma
The price of the underlying asset doesn’t directly affect Gamma, but it can indirectly influence it through its impact on the “moneyness” of the option – whether it’s in the money (ITM), at the money (ATM), or out of the money (OTM). Gamma is typically highest for ATM options, as these options have the highest uncertainty regarding whether they will expire in the money, making them more sensitive to changes in the underlying asset’s price. As the option moves ITM or OTM, Gamma tends to decrease, as these options have a higher certainty of remaining ITM or OTM.
3. The Effect of Implied Volatility on Gamma
Implied volatility (IV), the market’s forecast of a likely movement in a security’s price, has a direct impact on Gamma. Higher IV indicates a greater expected price range of the underlying asset, which increases the uncertainty of the option ending up in the money and, therefore, Gamma. As IV increases, options become more expensive, and the rate at which the option’s Delta changes (Gamma) also increases. Conversely, if IV decreases, the expected price range of the underlying asset narrows, reducing the option’s uncertainty and Gamma.
4. The Effect of Time on Gamma
The passage of time has a significant impact on Gamma. As an option approaches expiration, its Gamma increases, reflecting the increasing sensitivity of the option’s Delta to changes in the underlying asset’s price. This is because there’s less time for the underlying asset’s price to move, which increases the uncertainty of the option ending up in the money and, therefore, the rate at which the option’s Delta changes.
5. What Does Gamma Scalping Mean in Reference to Delta?
Gamma scalping is a strategy used by options traders to profit from changes in the price of the underlying asset, regardless of the direction of the price movement. It involves adjusting the size of a position in the underlying asset to keep the portfolio’s Delta near zero, which is also known as being Delta neutral.
When the price of the underlying asset increases, the option’s Delta increases due to positive Gamma, creating a long position. The trader can then short sell the underlying asset to bring the portfolio’s Delta back to zero. Conversely, when the price of the underlying asset decreases, the option’s Delta decreases, creating a short position. The trader can then buy the underlying asset to bring the portfolio’s Delta back to zero. By continuously adjusting the portfolio to remain Delta neutral, the trader can profit from the changes in the price of the underlying asset.
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