What is ‘Gamma’

Gamma is the rate of change in an option’s delta per 1-point move in the underlying asset’s price. Gamma is an important measure of the convexity of a derivative’s value, in relation to the underlying. A delta hedge strategy seeks to reduce gamma in order to maintain a hedge over a wider price range. A consequence of reducing gamma, however, is that alpha will also be reduced.

Explaining ‘Gamma’

Gamma Behavior

Since an option’s delta measure is only valid for short period of time, gamma gives portfolio managers, traders and individual investors a more precise picture of how the option’s delta will change over time as the underlying price changes. As an analogy to physics, the delta of an option is its “speed,” while the gamma of an option is its “acceleration.” Gamma decreases, approaching zero, as an option gets deeper “in-the-money,” as delta approaches one. Gamma also approaches zero the deeper an option gets “out-of-the-money.” Gamma is at its highest approximately “at-the-money.”

Further Reading