Gamma
Gamma
A Gamma ladder illustrates the risk in an option as spot and time change, and also due to the volatility curve. The ladder is used by option traders to manage the spot position caused by these shifts.
Gamma Ladder
Gamma can be positive or negative dependent on the position taken. Option buyers experience positive gamma, ie. a change in spot benefits the value of the option and also increases the underlying position in a positive manner. Option sellers experience negative gamma, a change in spot decreases the value of the option and also increases the underlying position but in a negative manner. Option buyers lose value due to time decay and option sellers gain value due to time decay
About Gamma
• Gamma
Gamma is simply, the change in delta at various levels of spot.
• Ladder
The ladder shows the impact at the various spot levels.
• Traders that have purchased options
Outside of a strategic position, ie. buying an option and limiting the risk to the premium paid, a trader can hedge the purchased option by selling shares in the same delta amount. If call options on 100 shares were bought at 50 delta the buyer is essentially long 50 shares. The hedge is to sell 50 shares of the underlying. As spot falls and the value of the call options decline, the short share position offsets the loss.
• Traders that have sold option
A trader that has sold an option, gains the premium received but is subject to exercise by the buyer. The seller can also hedge the delta amount. For a 50 delta call option on 100 shares sold, the trader is essentially short 50 shares. The trader buys 50 shares. If spot rises and the option buyer exercises the call, the trader can deliver the shares.
• Gamma
Gamma helps the trader to manage the risk by providing expectations of the delta under various spot, time and volatility assumptions.
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