What is Gamma?

Gamma is one of the less talked about Greeks that affect an options price. Gamma is the rate of change of delta per 1 point move in the underlying asset's price. Because it measures the rate of change of delta, gamma is the first derivative of delta. When the price of a stock moves, the delta of the stock moves as well. Gamma helps measure how much the delta will change by when the underlying's price moves.

If delta is the "speed" of an option, gamma tells investors about the "acceleration" - the rate of change of the speed or delta of an option. Gamma tends to be the highest when the option is near or at the money while deep in or out of the money options will have a low gamma. 

Consider the following example - $BMO's $100 call option has a delta of 0.50 and a gamma of 0.2. If $BMO increases by  $1, the delta will increase by the gamma value to 0.52. If $BMO decreases by $1, the delta will decrease by the gamma value to 0.48. The same is true for put options. A put option with a delta of -0.50 and a gamma of 0.02 will see delta move to -0.52 if $BMO decreases by $1 and -0.48 if the price increases by $1. 

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Long vs Short Gamma

Option strategies can be divided into long gamma and short gamma strategies. Long calls and puts are considered long gamma strategies while short calls and puts are short gamma strategies. Traders that use long gamma strategies want the underlying stock to keep moving in the one direction (either up or down) while short gamma traders want the option to stay at the starting price and expire worthless. In other words, gains for long gamma traders will grow exponentially as the stock continues to trend while losses on short gamma traders will grow exponentially as the stock continues to trend.

While gamma can be a somewhat tricky concept to grasp at first, it is important for investors to understand the difference between long gamma and short gamma and how it can impact changes in option pricing.