Lots of readers overthink. Everyone wants to be right. It’s easier than you think if you use “gamma”. It’s a commonplace feature of our reliable systems. Read on, you just might learn something.
Gamma Defined
In the world of options trading, gamma (“Γ”) is a measure of how much an option’s delta will change in response to a $1 change in the price of the underlying asset.
Here's a breakdown:
Delta measures how much the price of an option changes with a $1 move in the underlying asset.
Gamma measures how much delta changes with a $1 move in the underlying asset.
Key Points About Gamma
Gamma is highest for at-the-money options and decreases as options go deeper in-the-money or out-of-the-money.
Call and put options have positive gamma if you're long (i.e., you own the option).
Gamma is important for managing risk, especially for large or fast moves in the underlying asset.
Traders use gamma to understand how their position's sensitivity to the underlying asset is changing, which affects how aggressively they need to hedge.
Example
Suppose you own a call option with:
Delta = 0.50
Gamma = 0.05
If the underlying stock moves up by $1:
The delta will increase from 0.50 to 0.55
This means your option will gain value faster on the next $1 move
So, how do you use it like me?
It’s easy, we look for aberrations, in other words, excess valuations in gamma. Usually, we are looking to take advantage of the “herd.” You know how I feel about rookies in the market. They are often late to the party. Their trades, primarily in the put and call markets, are often made during a “fictitious” move. That’s where the “gamma” goes to the extreme, and we act. It is as simple as that. Buying low and selling high works.
I like Streisand. Her role in Funny Girl was second to none, especially when she sang “People.” Face it, people make the world go around. What we need to do is figure out the best way to take advantage of their actions. The herd is almost always wrong every time they act. Delta measures change, and gamma measures the rate of change. When the gamma exceeds its boundaries, we look for these aberrations and take action. It does not happen every day, but watching for it to occur does. More than fifty years of looking for these changes helps, just ask David Bowie.