Wednesday, 7 October 2015

How Option Delta and Gamma Influence Each Other

How Option Delta and Gamma Influence Each Other
As the market has been very volatile lately. Stocks have been moving in sometimes dramatic on a daily basis so it might be wise to review how option prices change when the underlying changes. The option “greeks” help explain how and why option prices move. Option delta and option gamma are especially important because they can determine how movements in the stock can affect an option’s price.
Option Gamma
The gamma of an option indicates how the delta of an option will change relative to a 1 point move in the underlying asset. In other words, the Gamma shows the option delta's sensitivity to market price changes.
Gamma is important because it shows us how fast our position delta will change as the market price of the underlying asset changes. When you are "long gamma", your position will become "longer" as the price of the underlying asset increases and "shorter" as the underlying price decreases. If you sell options, and are therefore "short gamma", your position will become shorter as the underlying price increases and longer as the underlying decreases.
Option Delta
The delta of an option is the sensitivity of an option price relative to changes in the price of the underlying asset. It tells option traders how fast the price of the option will change as the underlying stock/future moves.
Call Options
Whenever you are long a call option, your delta will always be a positive number between 0 and 1. When the underlying stock or futures contract increases in price, the value of your call option will also increase by the call options delta value. Conversely, when the underlying market price decreases the value of your call option will also decrease by the amount of the delta.
Put Options
Put options have negative deltas, which will range between -1 and 0. When the underlying market price increases the value of your put option will decreases by the amount of the delta value. Conversely, when the price of the underlying asset decreases, the value of the put option will increase by the amount of the delta value.
Option delta and option gamma are critical for option traders to understand particularly how they can affect each other and the position. A couple of the key components to analyze are if the strike prices are ATM, ITM or OTM and how much time there is left until expiration. An option trader can think of option delta as the rate of speed for the position and option gamma as how quickly it gets there.

 

 


 

 

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