An Option Gamma measures the change in Delta for every one dollar change in the underlying price of the stock. If the Delta of an option goes from .5 to .6 and the stock increases by $1.00, the gamma is .1. Gamma belongs to a group of option measures called “the Greeks”. In the money options have a low Gamma because they already trade at a very high Delta. Out of the money options have the potential for explosive Gamma. When the stock price moves in the favor of the option, the Delta increases rapidly as the option goes from being far out of the money to at the money or in the money. When a trader is long Gamma, they are long out of the money options. In calculus, the Gamma is known as a second derivative. It measures the rate of change for Delta and Delta measures the rate of change in the price of an option relative to the price of the stock. This Greek is useful for traders that have complex spread positions. It allows them to gauge their exposure to very large moves in the underlying.
December 30, 20081 min read