Options Greeks: Gamma Risk and Reward

Gamma is one of the more obscure Greeks, but it has important implications in analyzing option strategies. It measures the rate of change of Delta, which is how much an option price changes given a one-point movement in the underlying asset. Delta increases or decreases along with the underlying asset price, whereas Gamma is a constant that measures the rate of change of Delta (see table below for an example of an in-the-money call option).

For example, suppose that two options have the same Delta value, but one option has a high Gamma and one has a low Gamma. The option with the higher Gamma will have a higher risk since an unfavorable move in the underlying stock will have an oversized impact. High Gamma values mean that the option tends to experience volatile swings, which is a bad thing for most traders looking for predictable opportunities.

How Gamma Impacts Strategies

A good way to think of Gamma is the measure of the stability of an option’s probability. If Delta represents the probability of being in-the-money at expiration, Gamma represents the stability of that probability over time. An option with a high Gamma and a 0.75 Delta may have less of a chance of expiring in-the-money than a low Gamma option with the same Delta.

The table below shows position Gamma signs for common option strategies:

While Gamma entails a higher level of risk, it’s not always a bad thing for those that are long options. Gamma accelerates profits for every $1.00 that the underlying asset price moves in a long trader’s favor and decelerates losses for every $1.00 that the underlying asset price moves against them. In essence, every dollar that the underlying asset price increases results in increasingly efficient returns on the trader’s capital. 

The Bottom Line

Gamma tells us how fast Delta changes when the underlying asset price moves. It’s most helpful for seeing the stability of an option’s probability of reaching its strike price before expiration. Higher Gammas tend to be riskier than lower gammas even if the Delta remains the same.