Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Gamma Risk====== 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. ===== What Exactly Is Gamma? ===== 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. * If the underlying stock price increases by $1, your option's price will increase by approximately $0.50 (the delta). * But that's not all! The gamma of 0.10 tells you that the delta itself will also increase. Your new delta will be 0.50 + 0.10 = 0.60. * Now, for the //next// $1 increase in the stock price, your option will gain $0.60, not the original $0.50. 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. ===== The Dangers of Gamma Risk ===== 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 At-the-Money Cliff ==== 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. ==== The Gamma Squeeze ==== 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: - **Step 1: The Setup.** A large number of investors start buying short-dated, out-of-the-money call options on a particular stock. - **Step 2: The Hedge.** [[Market makers]] and investment banks sell these options. To hedge their risk, they must buy a certain amount of the underlying stock, a practice known as [[delta hedging]]. - **Step 3: The Ignition.** As buying pressure pushes the stock price up towards the options' strike prices, the delta of those options increases rapidly (thanks to gamma!). - **Step 4: The Feedback Loop.** To maintain their hedge against this rising delta, market makers are forced to buy //more// of the underlying stock. This new wave of buying pushes the stock price even higher, which in turn increases the options' delta again, forcing yet another round of buying. 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. ===== Gamma Risk for Value Investors ===== 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.