The option's gamma is a measure of the rate of change of its
. The gamma of an option is expressedas a percentage and reflects the change in the delta in response to a one point movement of the underlyingstock price.Like the delta, the gamma is constantly changing, even with tiny movements of the underlying stock price. Itgenerally is at its peak value when the stock price is near the
of the option and decreases asthe option goes deeper into or out of the money. Options that are very deeply into or out of the money havegamma values close to 0.
Suppose for a stock XYZ, currently trading at $47, there is a FEB 50 call option selling for $2 and let'sassume it has a delta of 0.4 and a gamma of 0.1 or 10 percent. If the stock price moves up by $1 to $48,then the delta will be adjusted upwards by 10 percent from 0.4 to 0.5.However, if the stock trades downwards by $1 to $46, then the delta will decrease by 10 percent to 0.3.
Passage of time and its effects on the gamma
As the time to expiration draws nearer, the gamma of
options increases while the
options decreases.The chart above depicts the behaviour of the gamma of options at various strikes expiring in 3 months, 6months and 9 months when the stock is currently trading at $50.
Changes in volatility and its effects on the gamma
When volatility is low, the
options is high while the gamma for deeply into or out-of-the-money options approaches 0. This phenomenon arises because when volatility is low, the
of such options are low but it goes up dramatically as the underlying stock price approaches the