Gama – Definition

Cite this article as:"Gama – Definition," in The Business Professor, updated July 30, 2019, last accessed August 14, 2020, https://thebusinessprofessor.com/lesson/gama-definition/.

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Gamma Definition

Gamma is a tool used to measure the rate of an option’s price changes with regard to the underlying asset. Gamma that is positive is an indication that the trading position is also positive. Contrarily, when there is an upward or downward movement in the underlying asset’s price, then the position is always of higher value from that of the delta.

Key Takeaways

  • Gamma is a tool used to measure the rate of an option’s price changes with regard to the underlying asset.
  • Gamma is at its largest when the option under measurement is either near or at the cash.
  • Options in a long position have positive gamma and vice versa.

A Little More on What is Gamma

Gamma as a delta’s derivative is used to measure option’s movement price as per the money or the amount of money the option is in. Note that gamma is regarded to be small when the option under measurement is either in or out of the cash. On the other hand, gamma is at its largest when the option under measurement is either near or at the cash. Generally, options in long position have positive gamma and vice versa.

Also, note that the delta measure of an option is always valid for a short duration. This means that traders are in a position to get a true picture of how the delta of the option is bound to change with regard to the price changes of an underlying asset. Using a physics version, option’s delta can be said to be speed whereas the option’s gamma is the acceleration.

Calculating Gamma

To effectively deal with the complexity of calculating gamma, it will be easier if you used either spreadsheets or software for finance. This will help you to arrive at a precise value during the calculation. The following example shows how gamma is calculated:

Example

Assume that the option of a particular stock is 0.4 delta. Also, suppose the value of the stock goes up by $1, then the option’s value will also go up by 0.40 resulting in delta change. Let’s again assume that following the $1 increase, the delta of the option changes to $0.53. This means that the deltas’ difference of 0.13 can then be taken to be a gamma’s approximate value.

Importance of Gamma

Gamma can be used to correct issues related to convexity especially when you want to engage hedging strategies. Portfolios of large value require an additional precision when engaging in hedging. In this case, a derivative known as color can be applied. This derivative can be used to measure gamma’s rate change as well as maintaining the portfolio of gamma-hedged.

References for “Gamma”

 

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