In options trading, traders are often presented with Greek letters that represent mathematical measures of the sensitivity of the option price to different variables, which are products of the option pricing model, and through these measures, option traders can more accurately assess the risk exposure of the option and construct the appropriate risk management as well as trading strategies.
The Greek letters commonly used in options trading are as follows: Delta (Δ), Gamma (Γ), Theta (Θ), Vega (ν), Rho (ρ). The connotations of Gamma (Γ) are described below.
Option P&L = Delta P&L + Gamma P&L + Vega P&L + Theta P&L + other small factors P&L.
Gamma (Γ)
Definition: Gamma is the partial derivative of Delta with respect to the price change of the underlying asset.
Meaning: Gamma measures the rate at which delta changes in response to changes in the price of the underlying asset; the higher the value of gamma, the higher the sensitivity of delta to changes in the price of the underlying asset.
e.g. if the futures price is 200, a 220 call has a delta of 30 and a gamma of 2.
If the futures price increases to 201, the delta is now 32. Conversely, if the futures price decreased to 199, the delta is 28.
Just like delta, gamma is dynamic. It is the highest when the underlying price is near the option’s strike price.
Application: The Gamma value allows option traders to construct volatility trading strategies by purchasing a portfolio of options with a positive Gamma value in anticipation of increased market volatility. However, when the Gamma value is too large, option traders need to be aware of the risks associated with rapid fluctuations in option prices.
