Understanding Gamma: Why Options Risk Accelerates Faster Than You Expect

In options trading, Gamma is the second derivative, and represents the force which determines an option’s price in relation to the underlying asset’s price.

In practical terms, Gamma determines the rate of change in Delta for every $1 move in the stock.

How Gamma Works

While Delta is the speed of your option price, Gamma represents acceleration of the price movement speed, allowing you to gauge how your risk profile changes while you’re still in the trade.

It is the only Greek that tracks the stability of your exposure. Without Gamma, you are essentially assuming the market moves in a straight, predictable line.

Gamma can be easily calculated by understanding the math behind it, which is called the Black-Scholes model.

Gamma = (ΔDelta) / (ΔPrice of Underlying)

Example:

• Step 1: Your call option has a 0.50 Delta.
• Step 2: The stock moves up by $1.00.
• Step 3: You check your platform and see the Delta is now 0.55.

The change in Delta ($0.05$) divided by the change in price ($1.00$) equals a Gamma of 0.05.

Proximity and Moneyness

Gamma is not distributed evenly across all strike prices. It clusters mainly around At-the-Money (ATM) options.

This aggressive clustering is the main reason you’ll see highly erratic price behaviour near large open interest levels, where market makers have to hedge their Gamma exposure, thus creating a feedback loop in the price of the underlying asset.

The Gamma Ramp

You cannot think of Gamma without having Theta (time decay) in mind first, as it affects Gamma for at-the-money options by increasing it as expiration time approaches. This is called the Gamma Ramp.

While longer-dated options do not suffer from this as much, the most popular type of options trading, 0DTE (Zero Days to Expiration) options, are affected greatly bi it.

As short-term options have extremely high levels of Theta, even a small price move can swing an option greatly, so we recommend that you never evaluate Gamma without first looking at Theta, as high Gamma usually comes at the cost of high Theta.

How To Manage Gamma Strategically

The most important strategic approaches to managing your Net Gamma have all to do with risk mitigation and position sizing.

First and foremost, the risk in high Gamma options scales non-linearly, so you have to keep in mind that even a position that at first looks completely safe can double its exposure in minutes.

You also have to keep in mind that standard stop-losses can be highly ineffective in these environments, as Gamma accelerates your Delta, increasing your risk at the moment of exit than what your initial models predict.

You also have to monitor your portfolio Gamma, especially if the majority of your book is Short Gamma, for example. In these scenarios, even a single unexpected shock can trigger a Gamma-weighted drawdown that can easily exceed the total sum of your individual stop-losses.

Final Thoughts

We hope that this simple guide has shed some light regarding the importance of Gamma in options trading. By mastering the knowledge of this and other Greeks, the market will become much more predictable and allow you to manage your positions with high levels of precision.