Option Gamma In a market where the stock bounces around like a y

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Option Gamma
The gamma of an option indicates how the delta of an option will change relative to a 1 point move in the underlying asset. In other words, the Gamma shows the option delta's sensitivity to market price changes.

Gamma is important because it shows us how fast our position delta will change as the market price of the underlying asset changes.

Remember: One of the things the delta of an option tells us is effectively how many underlying contracts we are long/short. So, the Gamma is telling us how fast our "effective" underlying position will change.

In other words, Gamma shows how volatile an option is relative to movements in the underlying asset. So, by watching your gamma will let you know how large your delta (position risk) changes.



The above graph shows Gamma vs Underlying price for 3 different strike prices. You can see that Gamma increases as the option moves from being in-the-money reaching its peak when the option is at-the-money. Then as the option moves out-of-the-money the Gamma then decreases.

Note: The Gamma value is the same for calls as for puts. If you are long a call or a put, the gamma will be a positive number. If you are short a call or a put, the gamma will be a negative number.

When you are "long gamma", your position will become "longer" as the price of the underlying asset increases and "shorter" as the underlying price decreases.

Conversely, if you sell options, and are therefore "short gamma", your position will become shorter as the underlying price increases and longer as the underlying decreases.

This is an important distinction to make between being long or short options - both calls and puts. That is, when you are long an option (long gamma) you want the market to move. As the underlying price increases, you become longer, which reinforces your newly long position.

If being "long gamma" means you want movements in the underlying asset, then being "short gamma" means that you do not want the price of the underlying asset to move.

A short gamma position will become shorter as the price of the underlying asset increases. As the market rallies, you are effectively selling more and more of the underlying asset as the delta becomes more negative.

Long Gamma Trading
Take a look at this video from Options Unversity. It provides an overview of the concept of Gamma Trading.

Options Market Makers Grapple With ‘Gamma Risk’ In Goldman
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close StumbleUponYahoo! BuzzMySpacedel.icio.usRedditLinkedInFarkViadeoOrkut Text By Peter A. McKay
Tennille Tracy, of Dow Jones Newswires, writes:

If you happened to take a walk on the floor of the Chicago Board Options Exchange right now, you’d probably find one group of traders going totally nuts.

Those would be the traders who make a market in Goldman Sachs options, the people whose job is to take the other side of investors’ orders to buy and sell options in the bank.

A big move in Goldman shares–like the 16% plunge that took place at Friday’s intraday low–always wreaks havoc on these market makers. But Friday presents a particularly thorny challenge because April options expire at the end of the session.

“The fact that this happened on expiration Friday is a real kick in the teeth,” said Jud Pyle, chief investment strategist at Peak6 Investments.

Going into expiration, market makers hold massive positions in options that may or may not be worth something at the end of the day. If Goldman Sachs shares trade at $184, like it did Thursday, then an April $170 put option is likely to expire worthless. Put options convey the right to sell stock in a company at a fixed price. The April $160 put, meanwhile, is even more likely to expire worthless.

Market makers keep those assumptions in mind when they hedge their positions in those contracts–a concept in options called “gamma.”

But when the U.S. Securities and Exchange Commission charged the bank with fraud and the stock price dived to an intraday low of $155.55, the April $170 puts and April $160 puts are suddenly “in the money” and could very well be exercised by investors who own them.

As the stock makes those kinds of moves, market makers have to work fast to readjust their hedges–buying and selling millions of shares of Goldman stock that they’ve used to offset their options holdings.

In a market where the stock bounces around like a yo-yo on a string, that task becomes considerably more difficult and yet all the more crucial.

In fact, Pyle said a decent amount of the trading volume in Goldman’s stock Friday is due to market makers adjusting those hedges.

“Right now, some of them are crying and some are happy,” he said.

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• Gamma Scalping vs. Bleeding -marketreflections- ♂ (4340 bytes) () 07/24/2010 postreply 17:35:45

• Gamma represents the change in delta for a given change in the s -marketreflections- ♂ (6149 bytes) () 07/24/2010 postreply 17:45:52