Options trading has witnessed a strong growth in India and in other markets worldwide. However, traders should be aware that options trading comes with high risk of losing capital and it is advisable to keep a close watch on data before trading in options. Options trading needs knowledge of many technical aspects and one of them in gamma in trades.

Option delta quantifies the sensitivity of an option's price to fluctuations in the price of its underlying asset. Gamma, another essential Greek in options trading, serves as a second-order measure, capturing the sensitivity of delta to changes in the underlying asset's price. In essence, while delta is a dynamic metric, gamma elucidates the extent to which delta will adjust in response to variables such as interest rates, volatility, and time to expiration.

Elucidating Gamma in Options Trading

Gamma signifies the rate of change in delta for a unit price alteration in the underlying stock or index, thereby measuring movement risk or momentum. Similar to delta, gamma values oscillate between 0 and 1. For traders, gamma's value is contingent on their position; a long call or put option results in positive gamma, while a short call or put option yields negative gamma.

Gamma Dynamics with Practical Illustration

Gamma peaks when the strike price approximates the stock price, particularly in at-the-money (ATM) options. At this juncture, the delta's susceptibility to price changes is maximized. Conversely, as options delve deeper in-the-money (ITM) or out-of-the-money (OTM), gamma's impact on delta diminishes, forming a bell-shaped curve with its apex around ATM options.

Consider a stock trading at Rs.1050, with an out-of-the-money (OTM) 1070 call option priced at Rs.20. Also assume that the option has a delta of 0.4 (40%) and gamma of 0.1 (10%). If the stock price ascends to Rs.1080, the call option should rise by Rs.12, multiplying delta by price rise (0.4*30=12).

Factors Influencing Gamma Value

Gamma, akin to delta, is inherently dynamic, influenced predominantly by time to expiry and stock price volatility. As expiry nears, ATM options experience a surge in gamma, whereas ITM and OTM options witness a reduction. For instance, options with one month to maturity exhibit a sharper gamma curve compared to those with three months, due to clearer visibility of delta shifts in the near term.

Volatility also modulates gamma; high volatility conditions result in a flatter gamma curve, attributed to substantial time value already embedded in the options, thus limiting delta shifts. Conversely, low volatility conditions produce a sharper gamma curve, indicating greater potential for delta changes.

Summary

In summary, gamma is an instrumental metric in options trading, delineating the rate of delta's change relative to the underlying asset's price variations. It provides critical insights into movement risk and momentum, with its value influenced by time to expiry and volatility. Mastery of gamma, alongside other Greeks, is pivotal for sophisticated options trading strategies, facilitating nuanced risk management and optimization of trading outcomes.