Gamma is an option greek that measures how much an option's delta is expected to change for a one-point change in the price of the underlying asset.
Gamma helps traders understand how quickly an option's sensitivity (delta) changes as the underlying asset moves. Gamma is highest for at-the-money (ATM) options and generally decreases for deep in-the-money (ITM) and deep out-of-the-money (OTM) options.
Gamma can be compared to a car's acceleration. Just as acceleration measures how quickly a car's speed changes, gamma measures how quickly an option's delta changes when the underlying asset moves.
Example
A call option has:
- Delta = 0.50
- Gamma = 0.02
Nifty is trading at 24,000.
If Nifty rises by 100 points to 24,100:
- Delta is expected to increase by approximately 0.02 × 100 = 0.20
- New delta ≈ 0.70
This means the option becomes more sensitive to further upward movements in Nifty.
If Nifty falls by 100 points to 23,900:
- Delta is expected to decrease by approximately 0.20
- New delta ≈ 0.30
This means the option becomes less sensitive to further price movements.
Why is gamma important?
Gamma helps traders:
- Understand how stable or unstable an option's delta is.
- Estimate how quickly directional exposure may change.
- Manage hedging positions more effectively.
- Identify options that may respond aggressively to market movements.
- Assess the risk of holding short option positions, which typically have negative gamma.
For option buyers, positive gamma means delta generally moves in their favour as the market moves. For option sellers, negative gamma means risk can increase rapidly during sharp market movements.
What are the limitations of gamma?
Some limitations include:
- Gamma measures changes in delta, not the option price directly.
- Gamma itself changes as market conditions change.
- It is most useful when used alongside delta.
- Gamma can increase significantly near expiry, making positions more difficult to manage.
- Large market moves can cause actual outcomes to differ from estimates.
For these reasons, traders often use gamma together with delta, theta, and vega when evaluating option positions.