What is Gamma?

What is Gamma - Sensitivity of an option's delta to changes in the underlying asset's price.
OPEN ACCOUNT
What is Gamma?
OPEN ACCOUNT
3 mins read
10-May-2024

Measuring options pricing is crucial for options traders. This understanding helps identify the most suitable trading strategies and manage risk effectively. “Gamma” is a popular tool used to measure how an option's price changes in response to shifts in the underlying asset's value. It determines the option's sensitivity to market movements.

Let us understand what is gamma, its close relationship with delta, and how it determines options pricing.

What is gamma in options?

Gamma (Γ) is a Greek letter and is widely used in the context of options trading. It measures how fast the delta of an option changes. Delta shows how an option's price shifts for every Rs. 1 shift in the underlying asset's price. Gamma indicates how sensitive the option's price is to changes in the underlying asset's price.

Let us understand better with the help of a hypothetical example

  • Say the stock of ABC Ltd. is currently trading at Rs. 100 per share.
  • Assume that there is a call option on ABC Ltd. with a:
    • Strike price of Rs. 105
    • Gamma of 0.05
    • Delta 0.40

Now, there could be two potential situations where the stock price of ABC Ltd. might increase or decrease. Understand both of them through the table below:

Aspects Situation I: The stock price of ABC Ltd. increases by Rs. 1 to Rs. 101 Situation II: The stock price of ABC Ltd. decreases by Rs. 1 to Rs. 99
Change in delta
  • In this case, the call option's delta will also increase due to its positive gamma.
  • With a gamma of 0.05, the new delta will become 0.45 [0.40 (old delta) + 0.05 (gamma)]
  • In this case, the call option's delta will decrease due to its positive gamma.
  • With a gamma of 0.05, the new delta will become 0.35 [0.40 (old delta) - 0.05 (gamma)]
Impact on options pricing
  • For every Rs. 1 increase in the stock price, the option's price will increase by Rs. 0.45 due to the increase in delta.
  • For every Rs. 1 decrease in the stock price, the option's price will decrease by Rs. 0.35 due to the decrease in delta.

 

What is the range of delta?

Gamma measures how fast delta changes itself. This delta carries a different range for both call and put options. Let us take a closer look:

Parameters For call options For put options
Delta range 0 to 1 -1 to 0
In the money (ITM)
  • When the call option is in the money, the delta approaches 1. 
  • The option's price changes very closely in relation to changes in the price of the underlying asset.
  • When the put option is in the money, the delta approaches -1.
  • This means the option price moves inversely with changes in the underlying asset's price.
  • In other words, when the price of the stock goes up, the price of the put option tends to go down, and vice versa.
Out of the money (OTM)
  • When the call option is out of the money, the delta approaches 0.
  • This means the option price changes very little in response to changes in the underlying asset's price.
  • When the put option is out of the money, the delta again approaches 0.
ITM Example
  • Let’s say the stock price increases and the option's delta is close to 1.
  • Now, this indicates that for every Rs. 1 increase in the stock price, the option's price will also increase almost by Rs. 1.
  • So, they move together very closely, like they are tied together.
  • Similarly, if the stock price decreases, the option's price will also decrease, almost in line with it.
  • Let’s say the stock price rises by Rs. 1, and the put option's delta is close to -1.
  • It indicates that for every Rs. 1 increase in the stock price, the put option's price will decrease by almost Rs. 1. 
  • This suggests an inverse relationship between the:
    • Stock price and
    • Put option's price
OTM Example
  • Let us say the stock price increases and the call option’s delta is 0.
  • The option's price won't change much in response to this increase in the stock price.
  • Similarly, let us assume that the stock price decreases and the put option’s delta is 0.
  • Again, there will be no change in the price of the option.


What is a good gamma for options?

Investors must understand that there is no universally acceptable gamma. Its suitability depends on an investor's:

  • Objectives
  • Risk tolerance, and
  • Trading strategy

However, we can still define the various gamma levels and their indications

Higher gamma

  • When gamma is high, it means the option's delta is more reactive to shifts in the underlying asset's price.
  • Traders seeking to profit from short-term price movements can prefer options with higher gamma.
  • These kind of options:
    • Offer quicker changes in value
    • Lead to higher profits if the market moves in the desired direction

Lower gamma

  • Lower gamma implies that the option's delta changes more slowly in response to changes in the underlying asset's price.
  • Investors looking to hedge their positions can prefer options with lower gamma.
  • These kind of options:
    • Provide more stability and
    • Are less affected by short-term fluctuations in the underlying asset's price

Conclusion

Gamma is popularly used in options trading to track the speed at which the delta of an option changes. It indicates how sensitive the option's price is to changes in the stock price. Investors must note that there's no universally "good" gamma. However, higher gamma options offer opportunities for short-term profits, while lower gamma options provide stability and are favoured for hedging strategies.

Expand your market understanding today! Learn about stock options and selling options to improve your trading knowledge.

Bajaj Finserv app for all your financial needs and goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

  • Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
  • Invest in fixed deposits and mutual funds on the app.
  • Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
  • Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
  • Apply for Insta EMI Card and get a pre-qualified limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on Easy EMIs.
  • Shop from over 100+ brand partners that offer a diverse range of products and services.
  • Use specialised tools like EMI calculators, SIP Calculators
  • Check your credit score, download loan statements and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more

GET THE APP

Disclaimer

1. Bajaj Finance Limited (“BFL”) is a Non-Banking Finance Company (NBFC) and Prepaid Payment Instrument Issuer offering financial services viz., loans, deposits, Bajaj Pay Wallet, Bajaj Pay UPI, bill payments and third-party wealth management products. The details mentioned in the respective product/ service document shall prevail in case of any inconsistency with respect to the information referring to BFL products and services on this page.

2. All other information, such as, the images, facts, statistics etc. (“information”) that are in addition to the details mentioned in the BFL’s product/ service document and which are being displayed on this page only depicts the summary of the information sourced from the public domain. The said information is neither owned by BFL nor it is to the exclusive knowledge of BFL. There may be inadvertent inaccuracies or typographical errors or delays in updating the said information. Hence, users are advised to independently exercise diligence by verifying complete information, including by consulting experts, if any. Users shall be the sole owner of the decision taken, if any, about suitability of the same.

Standard Disclaimer

Investments in the securities market are subject to market risk, read all related documents carefully before investing.

Research Disclaimer

Broking services offered by Bajaj Financial Securities Limited (BFSL) | Registered Office: Bajaj Auto Limited Complex , Mumbai –Pune Road Akurdi Pune 411035 | Corporate Office: Bajaj Financial Securities Ltd,1st Floor, Mantri IT Park, Tower B, Unit No 9 & 10, Viman Nagar, Pune, Maharashtra 411014| CIN: U67120PN2010PLC136026| SEBI Registration No.: INZ000218931 | BSE Cash/F&O (Member ID: 6706) | DP registration No : IN-DP-418-2019 | CDSL DP No.: 12088600 | NSDL DP No. IN304300 | AMFI Registration No.: ARN – 163403|

Research Services are offered by Bajaj Financial Securities Limited (BFSL) as Research Analyst under SEBI Regn: INH000010043. Kindly refer to www.bajajfinservsecurities.in for detailed disclaimer and risk factors

This content is for educational purpose only.

Details of Compliance Officer: Ms. Kanti Pal (For Broking/DP/Research)|Email: compliance_sec@bajajfinserv.in/Compliance_dp@bajajfinserv.in |Contact No.: 020-4857 4486 |

Investment in the securities involves risks, investor should consult his own advisors/consultant to determine the merits and risks of investment.

Frequently asked questions

What is option gamma?
Option gamma measures how quickly the price of an option changes in response to changes in the price of the underlying asset.
What is a good gamma for options?
There is no universally good gamma, as its ideal figure entirely depends upon your risk tolerance and trading strategy.
How is gamma connected with delta?
Gamma measures the rate at which the delta of an option changes.
Show More Show Less

Related videos