Chose optimal strikes with Option Gamma

In this article, we will discuss

• What is Gamma?
• Interpreting Gamma:
• How can Gamma help you become a options trader:

What is Gamma?

While Delta measures change in option price with respect to the underlying, Gamma measures the change in Delta with respect to the change in the underlying price.

As the underlying keeps on changing, the Moneyness of the Option (Deep ITM, ITM , ATM, OTM, Deep OTM) also keeps on changing. Due to this change in moneyness of the options contract, Delta is also constantly changing its value. Thus to understand how much the Delta will move with respect to change in underlying, we have to understand Gamma.

The value for gamma ranges between 0 and +1. In the case of long options, either calls or puts, the gamma is added to the option's delta when the stock price rises and subtracted when the stock price falls. In the case of a short options, gamma is subtracted from the option’s delta when the stock price increases, and added to the option’s delta when the stock price declines—the opposite impact on delta as compared to long options.

Interpreting Gamma

Gamma is generally higher for ATM options, because they are more sensitive to movement in the underlying than ITM / OTM options.

When gamma is high, it means your option's delta is changing rapidly with even small fluctuations in the underlying asset. This can be an advantage if you're looking to capitalize on short-term price swings.

But remember, gamma can be a double-edged sword. It can magnify your gains, but it can also increase your losses if the market doesn't go your way. That’s why Gamma is like the "accelerator pedal" of options trading.

How can Gamma help you become a options trader

Day traders and Option Scalpers who are focused on short-term price movements often seek higher gamma options to capitalize on short-term price fluctuations. If the direction of the trader is correct, then the Delta of these high gamma options will quickly move towards 1/-1 becoming more ITM. Thus, highest price change from this quick movement in underlying is captured by the strike having highest gamma.

Secondly, option traders who anticipate high volatility and significant price swings, should choose strikes with higher gamma. On the other hand, for those who expect stable or gradual price changes, options with lower gamma might suit.

Lastly, one important point to note is that gamma keeps increasing as we approach the expiry day. Hence, even small moves in underlying near to the expiry can accelerate a move in Delta which in turn will change the option prices significantly.

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