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Understanding Gamma Risk

Best Practices

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

In today’s Best Practices, we discuss how Gamma can improve the ability to use Delta as a hedging tool.

Gamma, by definition, represents how much the delta (directional risk) of an option changes after the underlying moves. When assessing options by Gamma, here are three characteristics for reference:

  • Long options have positive gamma exposure
  • Short options have negative gamma exposure
  • Gamma for near-the-money options increases as expiration approaches

While positive gamma strategies benefit from large market moves (like long strangles), negative gamma strategies benefit from minimal market moves. (like short strangles).

All else being equal, the directional exposure of options that are closer to expiration will be much more sensitive to underlying movements, so (as tastytraders) aim to close or roll positions (especially near-the-money options) 1-2 weeks prior to expiration.

Tune in for the final takeaways on how to use Gamma for individual positions as well as portfolio management!

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