Definition
The term gamma refers to the rate of change in delta for a one point change in the price of an underlying asset. An option's gamma is typically expressed in terms of a percentage change in delta for a one-point change in the underlying asset's price.
Explanation
An option's gamma tells the investor how fast delta will change if the price of the underlying asset changes by one point. While delta helps the investor to understand how much the value of an option will change for every one dollar change in the value of the underlying asset, gamma tells the investor the impact the change in the underlying asset's value has on delta.
Four generalizations can be made concerning gamma for a given option:
When an option is at-the-money, delta approaches 0.5 and gamma is maximized.
When an option is deep in-the-money or deep out-of-the-money, its delta approaches one and gamma approaches zero.
Gamma is positive for individuals that take a long position (holders of a call option) in the underlying asset.
Gamma is negative for individuals that take a short position (holders of a put option) in the underlying asset.
As is the case with delta, gamma is also a function of time to expiration and volatility. As an option approaches its expiration date, the gamma of an at-the-money option will increase and the gamma of an out-of-the money option approaches zero. If the price of the underlying asset is volatile, then gamma tends to remain constant, since the time value of an in-the-money or out -of the money option is relatively high. If the underlying asset price is relatively stable, the time value of the option approaches zero; therefore, gamma is relatively high.
Related Terms
The term hedge ratio refers to a mathematical formula that compares the value of a hedge to the value of the position in an asset. Calculating and tracking hedge ratios allows investors to understand and control their exposure to the price volatility of various assets.
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The term fungibility refers to the interchangeability of assets due to standardization. Trading and exchange of an asset is simplified if it possesses the characteristic of fungibility.Moneyzine EditorJanuary 18th, 2024
The term expiration Friday refers to the last business day an option can be sold, purchased, or exercised before it expires. Expiration Friday occurs each quarter, and is characterized by higher than normal price volatility and trading volumes.Moneyzine EditorJanuary 17th, 2024
The term expiration date refers to the final day the holder of an option contract can exercise their right under the agreement. After the expiration date, the seller of an option can no longer be assigned.Moneyzine EditorJanuary 17th, 2024
The term exercise by exception refers to the automatic exercise of in-the-money options at expiration. The Options Clearing Corporation (OCC) institutes exercise by exception unless explicit instructions prohibit exercising the option.Moneyzine EditorJanuary 17th, 2024
The term European option refers to an agreement that can be exercised only on a specific day prior to its expiration date. Call or put options involving stock market indexes are typically European-style options.Moneyzine EditorJanuary 17th, 2024
The term American option refers to an agreement that can be exercised at any time prior to, and including, its expiration date. Call or put options involving equities or common stock are typically American-style options.Moneyzine EditorJanuary 5th, 2024
