GAMMA - The Accelerator of Delta



Gamma is one of the important Option Greeks that measures the rate of change of an option's delta in response to a change in the underlying asset's price. It indicates the level of risk involved in a particular option trade due to changes in the underlying asset's price. Gamma is represented as the second derivative of the option price with respect to the underlying asset's price.


In simple terms, gamma is a measure of the sensitivity of an option's delta to changes in the underlying asset's price. As the price of the underlying asset changes, the delta of the option changes as well, and the rate of that change is the gamma.


For example, let's consider a call option with a delta of 0.5 and a gamma of 0.1. If the underlying asset's price increases by ₹1, the delta of the call option will increase by 0.1 to 0.6. Similarly, if the underlying asset's price decreases by ₹1, the delta of the call option will decrease by 0.1 to 0.4.


The effect of gamma on an option's value can be understood by considering two scenarios: at-the-money (ATM) and out-of-the-money (OTM) options.


ATM Options

When an option is ATM, the gamma is at its highest. This means that small price changes in the underlying asset will cause significant changes in the option's delta. For example, let's assume that the delta of an ATM call option is 0.5, and the gamma is 0.1. If the price of the underlying asset increases by ₹1, the delta of the call option will increase by 0.1 to 0.6. Similarly, if the price of the underlying asset decreases by ₹1, the delta of the call option will decrease by 0.1 to 0.4.


OTM Options

When an option is OTM, the gamma is at its lowest. This means that small price changes in the underlying asset will have minimal effect on the option's delta. For example, let's assume that the delta of an OTM call option is 0.1, and the gamma is 0.05. If the price of the underlying asset increases by ₹1, the delta of the call option will increase by 0.05 to 0.15. Similarly, if the price of the underlying asset decreases by ₹1, the delta of the call option will decrease by 0.05 to 0.05.


Conclusion

Gamma is an important concept in options trading as it helps traders to manage risk and create more effective trading strategies. High gamma options are more risky, but they can also provide higher potential returns. Low gamma options, on the other hand, are less risky but offer limited potential returns. Therefore, traders need to understand gamma and its impact on option pricing to make informed trading decisions.