Gamma Risk is the danger associated with the rate of change in an option's price sensitivity. That sounds like a mouthful, so let's unpack it. Think of an option's price as a race car. The car's speed—how fast its price changes when the underlying stock moves by $1—is called its delta. Now, imagine that speed isn't constant. The rate at which the car's speed changes is its acceleration. In the options world, that acceleration is called Gamma. Gamma Risk, therefore, is the risk that your option's price sensitivity (its delta) will change very quickly and unpredictably, especially as it gets closer to its expiration date. For an option seller, this is like driving a car whose accelerator has a mind of its own; a small tap on the gas (a small move in the stock price) could suddenly throw you from 20 mph to 120 mph, leading to rapid, and often painful, losses.
Gamma is one of the key “Greeks,” a set of metrics used to measure the different risks associated with an options position. While delta measures how much an option's price is expected to move per $1 change in the underlying stock, gamma measures the rate of change of the delta itself for that same $1 move. Let's use a simple example. Suppose you own a call option with a delta of 0.50 and a gamma of 0.10.
Gamma is highest for options that are at-the-money (ATM), meaning the stock's current price is very close to the option's strike price. It's the point of maximum uncertainty, and therefore, maximum acceleration.
High gamma can be a double-edged sword. For an option buyer, it can lead to explosive profits. For an option seller (the one taking on the risk), it can lead to catastrophic losses.
The biggest danger zone for gamma risk is when an at-the-money option is just days or even hours away from expiration. In this scenario, gamma skyrockets. The option's delta can swing violently from near 0 (behaving like it's worthless) to near 1.0 (behaving just like the stock) with very small movements in the underlying stock price. An options seller who thought they had a well-hedged position can find themselves suddenly exposed to massive risk, as their hedge becomes inadequate almost instantly. This is the “gamma cliff” – where the risk profile of the position changes dramatically in a very short period.
Perhaps the most famous—and dramatic—manifestation of gamma risk is the gamma squeeze. This market phenomenon became a household name during the 2021 surge in stocks like GameStop (GME). Here’s how it works:
This creates a powerful, self-reinforcing upward spiral where the act of hedging options drives the underlying stock price to extraordinary heights, completely disconnected from the company's fundamental value.
For a traditional value investing purist following the teachings of Benjamin Graham, complex derivatives like options are often seen as tools of speculation, not investment. The core philosophy is to focus on a business's intrinsic value and ignore short-term market noise. However, many modern value investors use options strategically. For example, they might sell cash-secured puts on a great company they'd love to own at a lower price or sell covered calls on a stock they own to generate extra income. For these investors, understanding gamma risk is not optional; it's essential. Even if you never touch an option, being aware of gamma risk is crucial. A gamma squeeze can cause a stock on your watchlist to soar to irrational prices. A savvy value investor recognizes this as a temporary distortion, not a change in the company's fundamentals. It might present a fantastic opportunity to sell an overvalued position, or a clear warning sign to avoid buying into the hype. Ultimately, gamma risk is a powerful reminder that in the short term, market prices can be driven by forces that have nothing to do with value.