The Skinny on Options: Abstract Applications

The Color of Gamma

The Skinny on Options: Abstract Applications

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

As we build our portfolios and structure our positions, we work hard to rely heavily on non-directional elements for our success, such as time or volatility. However, we inevitably still end up with some directional component to our trades, either intentionally or unintentionally. Well, when it comes to direction, delta effectively measures our degree of direction, and gamma captures the movement of delta. As a result, we are trying to avoid “gamma risk”, or gamma’s tendency to expand as we near expiration.

If we turn to the Black Scholes Model, we can mathematically express the foundations of gamma risk. Specifically, gamma risk would be best represented by “color”, or the derivative of gamma with respect to time. As we see, this equation for color shows us just how gamma does indeed change as our time evaporates and expiration draws closer.

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