Options Gamma and You
Options Gamma and You
The trifecta of option greeks are delta, theta and vega. But the next most important greek is gamma. Options gamma is a one of the so-called second-order options greeks. It is, if you will, a derivative of a derivative. Specifically, it is the rate of change of an optionís delta relative to a change in the underlying security.
Using options gamma can quickly become very mathematical and tedious for novice option traders. But, for newbies to option trading, hereís what you need to know:
When you buy options you get positive gamma. That means your deltas always change in your favor. You get longer deltas as the market rises; and you get short deltas as the market falls. For a simple trade like a long call, that means you make money at an increasing rate as the stock rises and lose money at a decreasing rate as the stock falls. Positive gamma is a good thing.
When you sell options you get negative gamma. That means your deltas always change to your detriment. You get shorter deltas as the market rises; and you get longer deltas as the market falls. Here again, for a simple trade like a short call, that means you lose money at an increasing rate as the stock rises and make money at a decreasing rate as the stock falls. Negative gamma is a bad thing.
Start by understanding options gamma from this simplistic perspective. Then, later, worry about working in the math.
About Dan Passarelli
Dan Passarelli, is the author of the book Trading Option Greeks and the president of Market Taker Mentoring LLC. Market Taker Mentoring provides personalized one-on-one mentoring for option traders. Dan started his trading career on the floor of the Chicago Board Options Exchange (CBOE) as an equity options market maker. He also traded agricultural options and futures on the floor of the Chicago Board of Trade (CBOT). In 2005, Dan joined CBOE’s Options Institute and began teaching both basic and advanced trading concepts to retail traders, brokers, institutional traders, financial planners and advisors, money managers, employees of the SEC and Federal Reserve bank, and market makers. In addition to his work with the CBOE, he taught options strategies at the Options Industry Council (OIC). Dan has been featured on television and radio and has written numerous articles in the financial press. Dan can be reached at dan@markettaker.com. He can be followed on Twitter.
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