Gamma
Candlefocus EditorMoreover, gamma is at its highest for options closer to expiration than farther-dated ones. This is because changes in the price of the underlying asset will have more of an effect on the option movement when there is less time for the market to react. Therefore, gamma can be used to measure how much changes in the underlying asset will affect the moneyness of an option.
Gamma is mostly used for delta-gamma hedging, which is a hedging technique involving the use of delta and gamma to immunize a position against possible movements in the underlying asset. Delta and gamma are both used for this because delta is a measure of the sensitivity of an option’s price to the underlying asset and gamma is a measure of the sensitivity of an option’s delta to the underlying asset.
Delta-gamma hedging works by adjusting the quantity of options being held to offset delta movements in the underlying asset. Gamma is used to determine how much the quantity of options needs to be adjusted and since gamma is at its highest when the option is at the money, the hedge is more effective closer to the money rather than further away.
In summary, gamma is the rate of change for an option's delta based on a single point move in the delta's underlying asset. It is a second-order risk factor and is used to measure how movements in the underlying asset will affect the moneyness of an option. Delta-gamma hedging is an important tool in managing an options position as it immunizes the position against moves in the underlying asset by adjusting the quantity of options held according to gamma readings.