Options Greeks (aka The Greeks) are used in trading to measure risks. Gamma is a popular Options Greek that, like the others, measures the sensitivity of changes. But, is the value of options Gamma limited to 1, like Delta, or can it be greater?
Options Gamma can be greater than 1 because there is technically no upper limit to the gamma values achievable. However, intuition is a lot more difficult compared to Delta. This is why it’s rare to find gamma values greater than 1, but it can happen in the presence of a steep Delta.
In the rest of this article, I’ll take a closer look at the options Gamma concept, why it is more complex compared to Delta, and why the values can be greater than 1.
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Why Can Gamma Values Be Greater Than 1?
Gamma can be greater than 1 because there’s no theoretical upper barrier on how steep Delta can go. So, theoretically, Gamma values can be greater than 1.
However, it’s very rare to see such values because Gamma intuition is more difficult compared to Delta bound to less than 1.
The actual value of Gamma reached comes down to the connection between the option’s strike price and the current price of the underlying asset—also known as Moneyness.
What Is Gamma?
In options trading, Gamma is very similar to Delta. They are both measures of how an option reacts to changes in the underlying price, although the measurement happens in different ways:
- Delta shows how much the premium on an option will change after the price of the underlying asset increases by $1.
- Gamma measures how much the Delta above will move, assuming the underlying price goes up by $1.
Think of Gamma as the acceleration of an option’s price change while Delta is the speed of the change.
How Gamma Can Change?
Gamma is the first derivative of Delta, and it is used when the focus is on measuring the price movement of an option in relation to just how much it is in or out of the money. Therefore, you can also regard Gamma as the second derivative of an options price in relation to the underlying asset’s price.
If the option under scrutiny is deeply out or in the money, Gamma is typically small. Conversely, Gamma is at its largest when the option is at the money.
All long position options have a positive gamma, while all short positions have negative Gamma.
How Is Gamma Calculated?
As I’ve mentioned above, Gamma is a first derivative of Delta or a second derivative in relation to the underlying price.
The calculation is generally complex, requiring the use of spreadsheets or other sophisticated software to arrive at an exact value. Plus, there is more than one single approach to calculate gamma. The formulas used in the calculation include the Black-Scholes Model.
Why Is Gamma Important in Options Trading?
Gamma is an important metric in options trading because it helps deal with convexity problems for traders using hedging approaches in their trading. Traders controlling large-value portfolios need all the precision they can get when hedging, which is why they often use a third-order derivative known as color.
This derivative measures Gamma fluctuations, making it an essential option for traders holding Gamma-hedged positions.
Gamma’s Relationship With Option Moneyness and Time to Expiration
Gamma is always highest when the option is at the money or very close. Gamma is also close to zero for options deep in the money.
So, when you see a graphical representation of Gamma on a chart, you’ll get the usual bell curve with a peak around the middle (signifying at the money) which then approaches zero on both ends (signifying in the money or out of the money).
Apart from the relationship with Moneyness, Gamma can also be affected by time. Gamma of an at-the-money option increases as the expiration draws closer. On a chart, the bell-curve shape markedly takes on a peaked appearance.
Options at the money and very close to expiry have the highest Gamma with typically unstable values. This is why some traders also look at Gamma as a measure of an option’s instability. On the flip side, both options in-the-money and out-of-the-money lose Gamma as the expiry draws closer. On the chart, both sides of a bell curve are pushed a little bit closer to zero.
How Does Volatility Affect Gamma?
In options, volatility affects Gamma in a manner similar to time:
- Higher volatility leads to similar values when there’s more time to expiration.
- Lower volatility equates to when there’s less time.
With rising volatility, you can expect Gamma to increase for in-the-money and out-of-the-money options. Gamma falls for options at the money in this scenario.
On the other hand, with decreasing volatility, Gamma for at-the-money options increases while it falls for options in the money or out of the money.
Can Gamma Movements Be Traded?
Many traders build strategies around Gamma movement. Non-directional or delta-neutral straddle strategies and hedging strategies are examples of how traders take advantage of Gamma in their trading.
Many traders choose to go with hedges. The most effective approach to hedging gamma is to buy short-term options already at the money. These tend to have the highest liquidity as well as the highest Gamma.
As you research Gamma strategies to deploy, it’s best to remember that even though all options have positive Gamma, short option positions will have negative Gamma.
Also, any options with positive Gamma means you’ll accrue profits faster in big moves, while negative Gamma means losses can accumulate faster.
Do You Need to Understand Gamma to Trade Options?
Like other options Greeks, you don’t need to understand Gamma deeply to trade options. It all depends on the angle you choose to take with your options trading. There are lots of approaches, and understanding Greeks like Gamma isn’t required for all of them.
Still, you’ll need a detailed understanding of Gamma and other Greeks like Delta and Theta for some strategies.
If you have plans of embracing multi-branched spread-based strategies – where some open long option positions are countering open short positions – you’ll need a better understanding of factors that affect any option’s price and how each of these factors interacts with other similar ones.
However, most traders can get by with a general knowledge of Gamma (and the other two main Greeks: Delta and Theta). Understanding how each of them is related to the price of an option can make you a more aware trader overall.
Any trader who’d rather not bother with the formulas and calculations can stick with strategies that pay more attention to the underlying asset movement using it to predict options direction.
Such strategies rely on technical analysis and unearthing repetitive market patterns to take advantage of.
Of course, technical analysis also requires some training. However, most new options traders can pick up these rule-based strategies faster than those built around the sophisticated options Greeks.
Whichever approach you choose to go with, endeavor to get all the knowledge you need before putting real money on the line.
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Options Gamma can be greater than 1, but you’re unlikely to witness this barring a steep change to the Delta value. Understanding Gamma and the factors that can affect it can help you create options trading strategies to take advantage of the fluctuations.
Traders with a proper understanding of Gamma often deploy it in hedging and straddling options strategies. However, you can also trade options without paying too much attention to Gamma or any of the options Greeks.
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