Gamma measures how much Delta changes when the underlying index moves by 1 point. Since Delta itself changes as the price moves, Gamma helps traders understand how quickly an option’s price will react to changes in the underlying index. A high Gamma means Delta will change rapidly, making the option more volatile. Gamma is highest for ATM options and lowest for deep ITM or OTM options.
Significance:
- Higher Gamma means rapid changes in Delta, leading to increased price fluctuations.
- ATM options have the highest Gamma, making them highly responsive to small price movements.
- Low Gamma means more stable Delta, which is common for deep ITM and deep OTM options.
- Essential for traders managing Delta-neutral or hedging strategies.
- Important for short-term options traders, as Gamma can lead to sudden price swings.
Example (Bank Nifty Put Option):
- A Bank Nifty 47,000 Put has Delta = -0.50, Gamma = 0.05.
- If Bank Nifty falls from 47,000 to 46,999, Delta will change from -0.50 to -0.45.
- If Bank Nifty drops further, the put option gains value faster because Delta becomes more negative.