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Trading Through Gamma

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

Gamma is defined as change in delta when the underlying price moves up by one dollar. This statement is quite vague, however, so let's dive a little deeper to understand its intuitive definition; think of gamma as an additional layer of risk on top of delta risk. So let’s say you have directional exposure to the upside, gamma will magnify that exposure when the stock moves against you. As such, can be thought of as the acceleration of risk.

Gamma becomes larger for at the money strikes closer to expiration and becomes smaller for out of the money strikes closer to expiration. When the position is far from expiration i.e. 45 days away, gamma is pretty small for all strikes. This is why we prefer to trade in the 45 day window: there is less potential for excess risk.

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