What is the Gamma in Options Trading?

What is the gamma of an option? Gamma belongs to the so-called option Greeks. It describes the change in the option delta, the most important key figure in options trading. The delta indicates how much the option price changes if the underlying asset changes by one euro, while gamma shows us how much the delta changes if the underlying asset rises or falls by one unit. But why should you know this?

What it is good for

The point is to use gamma to estimate more accurately how strong the change in delta and thus the change in the option price will be. Gamma helps an option investor to better assess the impact of a change in the price of a stock in a particular direction on the option price.

A high gamma means that an option is close to the money. As the remaining life of the option decreases, the change in the delta, and thus the option price, becomes greater and greater as further price changes occur. This allows options traders to quickly gain an even better overview of the market, and they can see how the stock of options held is developing in terms of price. Conversely, traders can search for options in a more targeted manner if they want to operate in the market.

The Gamma of Options – Example

Five put options with only a short remaining term to maturity of 30 days are considered:

A delta of -0.50 indicates that the put is at the money. At the same time, if the options are close to the money, the gamma also assumes the highest value. This would be the case in the example with an exercise price of €47. The price of the stock is considered to be around 47 €. With the help of the delta and gamma, one could determine where the current price of an underlying asset is located.

What exactly does this mean for the options trader?

The gamma is a very useful tool, but the real benefit of the gamma is that investors can see how the option price or delta will move with a further change in price. For short-dated options that are relatively close to the money, price changes in the underlying asset have a relatively large impact. Options that are already far in or out of the money are less susceptible to price changes.

If you take the put option in the example again, you can see this effect quite clearly. The further the price falls below €47, the higher the profit, an option concluded with a strike of €47 or higher. This can be seen just as well on the delta. The delta gets bigger and bigger with a higher strike price.

However, you can also see that the gamma decreases slightly from the highest value at an exercise price of €47. This means that the further the price falls below 47, the less quickly the option price rises. Conversely, the option price also declines less quickly with increasing prices. Misjudgements by the option investor therefore have less of an impact.

In contrast, the closer an option is to the money, the greater the change in the option price.

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