The Gamma “Greek” is one of several math equations used by options traders to accurately calculate an option’s price movement. Gamma tells us how quickly an option’s price will move up or down.
Don’t ignore the Greeks, especially if you are new to options trading. Yes, they may seem complex, but they provide a lot of valuable insights that can help you determine whether or not to enter a trade. Specifically, they are simple math equations that provide important information about the sensitivity of option’s price movement.
Why is this important? Well, if you don’t know what to expect about an option’s price movement when you are buying a call, you are basically flying blind.
On the flip side, if you understand the probability of success when selling that call, you gain an edge over other traders who don’t use the Greeks.
The Gamma Greek works with Delta
Of all the Greeks, options traders believe Delta is the most important one. The others, including the Gamma Greek, support it.
Delta tells you how much an option’s price will move with a $1 move in the stock.
Gamma tells you how quickly that price will move. Will a stock’s price zip higher within a couple of days, or will it steadily move higher over the next three weeks? In other words, will it be the hare or the tortoise?
We need to know the speed, because all options decay in value as time goes on. If Gamma can tell us that this option will move higher more quickly than other names, then we have an edge.
Now, it doesn’t always work out this way but remember, trading is about probabilities and not perfection. When Gamma is high (the stock will move higher in price rapidly), just a small change in the price of the stock creates a huge surge higher in the option price.
Here’s an example:
A call option has a price of .50 and a gamma of .05. A $1 increase in the stock price increases the delta to .55. Not much you say? That is a 10% move in the option price, which is significant.
How to use Gamma
If you are long call or put options, look for options that have positive gamma. Once you identify those, look for “peak Gamma”.
Peak Gamma occurs when the stock price is very close to the strike price. At Peak Gamma, Delta’s sensitivity is highest, which means any flinch in the stock price can trigger a huge move up or down for the option.
In recent years the 0DTE, or zero days to expiration, have become hugely popular. These options carry high Gamma, so they are are very useful to follow.
As you get close to an expiration day, Gamma is calculated on what traders have on the books, along with an estimate for how large a move can be.
Again, this is not perfect information but a nice guideline. If you knew option players were holding names that are tilted towards a move to the upside, isn’t that useful? Of course it is, and you can slowly and gently follow the footsteps to a winning trade.
The Gamma of an option can be found in the options trading software you use (I use Interactive Brokers and TD Ameritrade).
Do you need a quick primer on options trading? Read this
For those of you new to options trading, I might have been throwing around terms you are just learning. Here’s a short primer:
Call options give you the right to buy an asset (like stock) at a certain price. Put options give you the right to sell an asset (at a certain price.
Each option has three terms: a strike price, expiration date, and premium value.
In addition, options can be at the money (ATM), in the money (ITM), or out of the money (OTM). Typically ITM has more value because it carries intrinsic premium. OTM carries the least value – time decay only.
You can find a full glossary of options trading terms here.
