Gamma is the ugly step child of option greeks. You know, the one that gets left in the corner and no one pays any attention to it? The problem is, that step child is going to cause you some real headaches unless you give it the attention it deserves and take the time to understand it. Gamma is the driving force behind changes in an options delta. Likewise, an option with a gamma of Gamma will be higher for shorter dated options. Most professional traders do not want to be short gamma during the last week of an options life.

Net sellers of options will be short gamma and net buyers of options will be long gamma. This makes sense because most sellers of options do not want the stock to move far, while buyers of options benefit from large movements. Get Your Free Standard Deviation Calculator. To get an idea of how gamma and delta work together, we will compare an at-the-money and an out-of-the-money call option.

In the picture below you can see that a 10 lot at-the-money call position has a positive delta of and a gamma of positive The call position has a delta of 86 and a gamma of The gamma for the at-the-money position is significantly higher. On the right side of the picture is a custom scenario.

Gamma Risk Explained

The delta for the calls has risen by to whereas the calls have only risen by We can do the same analysis using long calls with different expiry months. Here you can see that the Dec calls have a delta of and a gamma of The June, calls have a similar delta at , but a much lower gamma at The above analysis confirms that at-the-money options have higher gamma risk than out-of-the-money options and shorter dated options have higher gamma risk than longer dated options.

The gamma of an option will also be affected by Vega. When implied volatility on a stock is low, the gamma of at-the-money options will be high, while the gamma of deep out-of-the-money options will be near zero. This is because, when volatility is low, deep out-of-the-money options will have very little value as the time premium is so low.

Hughes Optioneering

However, option prices rise dramatically on a relative basis, as you move back along the option chain towards the at-the-money strikes. When volatility is high, and option prices are higher across the board, gamma tends to be more stable across the option strike prices. When volatility is high, the time value embedded in the deep out-of-the-money options can be quite high.

Therefore as you move from the outer strikes back towards the at-the-money strikes, the increase in time value is less dramatic. This concept is probably best explained visually. In the table below you can see the gamma of SPY calls when volatility is low VIX at The variation in gamma across the strikes is much smoother when volatility is high.

Therefore, you can assume that the gamma risk of at-the-money options is much higher when volatility is low. Here is the same data represented graphically. You can see when implied volatility is low, the gamma risk is much higher for the at-the-money strikes. So far we have only looked at individual options strikes. However, every option combination strategy will also have a gamma exposure.

Trades that require you to be a net seller of options, such as iron condors, will have negative gamma, and strategies where you are a net buyer of options will have positive gamma.

Below are some of the main options strategies and their gamma exposure:. First up we have two iron condors with the short strikes set at delta The weekly condor has a -4 gamma which is twice as high as the monthly condor at Clearly, the weekly condor has a much higher gamma risk. This is part of the reason why I do not like to trade weekly condors.

A small move in the underlying can have a major impact on your position. Next we will look at butterfly spreads comparing weekly, monthly, narrow and wide butterflies.

Comparing a weekly and monthly 10 point butterfly, we have an interesting situation, with both trades basically having zero gamma at initiation. This is due to the fact that the short strikes were exactly at-the-money with RUT trading at at the time. In any case, we see that with a The weekly butterfly has a whopping point change in delta! The monthly butterfly moves 73 points. We can deduce from the above that weekly trades have a much higher gamma risk. Butterflies have a higher gamma risk than iron condors and wide butterflies have the highest gamma risk of all the strategies.

This is summarized below:. Gamma scalping is like that hot girl from high school that you were never good enough for. Gamma scalping is not for everyone for a number of reasons. For starters you have to be pretty well capitalized as it can be very capital intensive.

Secondly, you need to have a very good understanding of how option greeks work before you even think about trading this way. The gamma scalping performed by market makers is an essential component of the efficient functioning of options markets as you will soon learn. This trade set up gave us a net delta exposure of , so to get to delta neutral, we buy 13 shares.

The reason is because of the positive gamma associated with the trade. As the price of IBM fluctuates, the delta will change because of the gamma exposure.

Being a positive gamma trade, price moves will benefit the trade. As IBM moves up, it will gain positive delta, as IBM moves down, the trade will pick up negative delta. In order to get back to delta neutral each time, we would need to either buy or sell IBM shares. As the stock moves down, we gain negative delta and need to buy shares buy low.

As the stock moves up we sell shares sell high to neutralize delta. Notice that we are buying low and selling high.

These transactions in the stock generate cash flow and can give rise to a profit providing the straddle does not lose too much value. See How This Trade Worked Out.

If the above sounds too good to be true, well it is, there is a catch in the form of Theta decay. We know that long options decay as time passes and this is the issue traders face with gamma scalping. The long calls and puts that make up the straddle will decay by a certain amount each day. If the stock does not move up and down enough, the time decay on the straddle will be greater than the profits from the stock trades. When gamma scalping, you want a stock that moves a lot during the course of the trade.

Option greeks work together rather than in isolation. Theta and Vega have a distinct relationship. If implied volatility is high, the time value embedded in options will be high. Therefore, options with high implied volatility will have a higher rate of Theta decay. It makes sense that it will be harder to gamma scalp on a stock with high implied volatility, as the stock will need to move much more in order to offset the losses from time decay.

Option Delta. How to understand and apply it to your trading

Dan Passarelli write a very good article on TheStreet. Even though you may not be willing or able to engage in gamma scalping, hopefully you now have a little bit more of an understanding of how the options markets works and how the different players all fit together.

You can read a bit more on gamma scalping here on Futuresmag. Now that we know a bit about gamma scalping and delta neutral trades, the next step would be to learn about neutralizing both delta and gamma. This article addresses one of the most important aspects of options trading: Overall, a good article.

Are you referring to the section on gamma scalping? If so, you want higher vol as that will increase the value of your long options. One thing I thought of to mention though. Like you said the shorter-term condors have higher gamma risk.

Blog My Story Work With Me Contact. Read This Free Report Volatility Trading Made Easy - Effective Strategies For Surviving Severe Market Swings. Market makers exchange members who provide liquidity are major players in the gamma-scalping arena. As they take the other side of public trades, they hedge the deltas and subsequently scalp gamma of long option positions. When market makers find they cannot cover their theta by gamma scalping because the underlying stock is not experiencing enough actual price oscillation, they are incented to try and sell their options to get out of the losing trade.

They lower their bids and offers some to try and attract buyers. In a way, the gamma scalping of market makers links together implied and historical volatility. November 28, at 4: Options Trading IQ says: November 29, at 2: December 27, at 3: December 27, at 4: February 1, at 6: February 2, at 8: Leave a Reply Cancel reply Your email address will not be published.

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