Options gamma is a part of the greeks and measures the delta rate of change. Delta tells you the amount of change in an options contract per $1 move. Delta moves up and down, whereas gamma stays constant. A higher gamma means the stock is much more volatile, which is good. However, if you’re a trader who likes more predictable trades, you’d want to avoid a contract with a high gamma.
What is Options Gamma?
Options gamma measures the rate of change of the delta. Delta tells you how much an options price changes given a $1 movement in a stock’s price. If security is $100, the strike is $100, the delta is 40, the gamma is 2, and the price goes up to $101, then the delta moves up to 42—important stuff to know when you’re trading options.
O.G. is a member of the Greek family in options trading. Gamma is one of the more ambiguous Greeks but is still important in analyzing different strategies. Learn about its importance when options trading in the video above.
Options trading strategies have many moving parts that can affect profit and loss. However, trading options are less expensive than trading shares. One option contract controls 100 shares, but you’re paying a premium instead of the price per share.
That makes it cheaper than buying 100 shares of a stock. However, options are more risky because of the many factors that affect different options.
Options Gamma - Rate of Change
Delta increases and decreases with a stock’s price, whereas gamma is the constant that measures that rate of change.
Stock options give you the right but not the obligation to buy or sell a stock at a specific price. Calls and puts are the bullish and bearish components.
The great thing about put options is that they’re like shorting, but all brokers have options, whereas not every broker has shares to short.
Options are a great tool for making money in any market. There are strategies for when a stock is moving up, down, and even sideways. However, since they tend to be risky, studying and practicing is imperative.
A stock may look attractive to you but can have a high gamma. An option with a higher gamma is a much riskier option. However, a contract with a lower gamma is less risky.
A high gamma means that any stock with an unfavorable swing will have a bigger negative impact. In essence, with high gamma, expect volatile moves. If you’re day trading options, this can be good if you choose the correct direction.
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Using to Form Strategies
While it may be one of the more obscure Greeks, it can be used to form your trading strategy. Just think of gamma as a way to measure the stability of an option.
Delta represents the probability of an option ending up in the money. It is representative of the stability of that probability happening over time.
Delta and gamma tend to work hand in hand. Options expire. As a result, you want to be able to profit before they do. However, 80% of options end up expiring worthless. That’s a lot of lost money.
That could be because people treat options like shares when they’re not. The Greeks, open interest, extrinsic value, and time decay affect how a contract profits or loses.
While that may seem overwhelming, don’t let it deter you from learning options. You can customize your options chain to show the parts you focus on.
Remember that gamma brings about a higher risk level. However, that’s not bad, especially if you’ve given yourself enough time. For every $1 a stock moves, gamma accelerates profit in your favor.
Gamma also decelerates loss for every $1 that price moves against you. In other words, for every $1 the trade you’re in moves, you’re getting a nice return on the capital you put up.
Options Gamma Direction
Just like trading shares, direction and patterns matter when trading options. One could argue even more so because of the affecting measures in options.
One of the great things about options is that you can get a much larger return on your investment with options than shares. The reason for that is the different factors that affect profit. However, those same factors can take your profit and quickly turn it into a loss. This is why paper trading options are so important.
Knowing patterns and candlesticks gives you a better chance of making a good trade. However, even the best traders fail 30-40% of the time.
Trades will go against you even if you have the best setup. It’s important to have proper risk management. It’s okay to close a losing trade and take a loss, especially with options.
Many times, options expire worthless because traders hold them, hoping they’ll recover. They either didn’t give themselves enough time or bought the wrong option. Hence, it is important to know what direction the stock is heading.
Bottom Line on Options Gamma
Options Gamma tells us how fast the delta changes when a stock moves. It’s most helpful to use it to see the stability of an option’s probability of reaching the strike price before it expires. Since options trading has so much that goes into it, take the time to study and practice.
If you need more help, take our options trading course.
Frequently Asked Questions
- Here’s what it means to be long gamma:
- Being long the option means that you want a higher gamma
- The delta of your security will increase based on the gamma of position
- Example: delta = $0.50 then contract moves up or down this amount per $1
A good gamma for options is around 40-60. This is when options are at the money. Deep-in-the-money and out-of-the-money options have a lower gamma because their deltas don't change as quickly.
Gamma is high for at-the-money strike prices. It's low for deep in the money and out of the money. The higher the gamma, the more volatile the stock.