Your Inside Source for Options Information

November 15, 2018

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Gamma is the second most commonly used Greek, coming only after Delta

How Delta is expected to change given a $1 move in the underlying is called Gamma. An investor can see how the Delta will affect an option's price given a $1 move in the underlying, but to see how the Delta on that option might change given the same $1.00 move, we refer to Gamma. Gamma will be a number anywhere from 0 to 1.00. Since Delta cannot be over 1.00, Gamma cannot be greater than 1.00 either as Gamma represents the anticipated change in Delta.

Looking at a hypothetical example, XYZ is trading 50. The XYZ Jan 50 call is trading for $2, has a Delta of .50 and a Gamma of .06. Should XYZ go up to $51, an investor can estimate that the 50 strike call will now be worth around $2.50. The new Delta of this 50 strike call at an XYZ price of $51 should be around 0.56 (simply adding the Gamma of .06 to the old Delta of .50).

In other examples

For the purpose of adjusting Delta amounts, round Gamma to two decimal places

• A call has a Delta of .54 and Gamma of .0400 (.04)
• Stock goes up $1
• Delta will become more positive by the Gamma amount
• New Delta value: .58
• Another call has a Delta of .75 and Gamma of .0340 (.03)
• Stock is down $1
• Delta will become less positive by Gamma amount
• New approximate Delta value: .72

Long options, either calls or puts, always yield positive Gamma. Short calls and short puts will have negative Gamma. Underlying stock positions will not have Gamma because their Delta is always 1.00 (long) or -1.00 (short) and will not change. Positive Gamma means that the Delta of long calls will become more positive and move toward +1.00 when the stock price rises, and less positive and move toward 0 when the stock price falls. Long Gamma also means that the Delta of a long put will become more negative and move toward –1.00 if the stock price falls, and less negative and move toward 0 when the stock price rises. For a short call with negative Gamma, the Delta will become more negative as the stock rises, and less negative as it drops.

Gamma is higher for options that are at-the-money and closer to expiration. A front-month, at-the-money option will have more Gamma than a LEAPS® option with the same strike because the Delta of the near term options move toward either 0 or 1.00 is imminent. With higher Gamma, investors can see more dramatic shifts in Delta as the underlying moves, especially with the underlying around the strike at expiration.

Gamma is lower in the longer-dated LEAPS® as more strikes remain possibilities for being in-the-money at expiration because of the amount of time remaining. An at-the-money-option’s Delta is typically the most sensitive to moves in the underlying (hence higher Gamma). With the stock right at a strike at expiration, an option’s Gamma will be at its highest as the Delta will be potentially moving from 1.00 toward 0 or vice versa as the underlying crosses a strike. In these cases, the Gamma can be extremely high as the Delta changes rapidly with the underlying at the strike and expiration approaching.

Deep-in-the-money or far-out-of-the-money options have lower Gamma than at- the-money options. The deep-in-the-money options already have a high positive or negative Delta. If the options become deeper in-the-money, the Delta will move toward 1.00 (or -1.00 for puts) and the Gamma will decrease because the Delta cannot move past 1.00. If the stock were to move toward the strike of the deep-in-the-money option, the Gamma will increase and the Delta moves lower approximately by the amount of the current Gamma.

For example, let’s say XYZ is trading at $30. A 25 strike call is trading for $5.80 and has a Delta around .85 and a Gamma of .03. If XYZ were to drop to $29, the investor might expect the option premium to drop to $4.95 (as projected by Delta). With stock at $29, the Delta of the option will be decreasing by approximately the amount of the Gamma, so the new Delta at an XYZ price of $29 might be .82 (here we subtract the Gamma from the old Delta as the stock price declined by $1). With the stock moving down toward the long strike, Gamma increases and impacts Delta. Should the stock decline to $25, we’d estimate Delta to be around .50. If the Gamma stayed around .03, the option would still have a .70 Delta with the stock at $25. However, since Gamma typically increases as options become closer to at-the-money, the new Gamma of this contract may be around .09.

Gamma is highest when the Delta is in the .40-.60 range, or typically when an option is at-the-money. Deeper-in-the-money or farther-out-of-the-money options have lower Gamma as their Deltas will not change as quickly with movement in the underlying. As Deltas approach 0 or 1.00 (or 0 or -1.00 for puts), Gamma is usually at its lowest point.

Implied volatility changes will also have an effect on Gamma. As implied volatility decreases, Gamma of at-the-money calls and puts increases. When implied volatility goes higher, the Gamma of both in-the-money and out-of-the-money calls and puts will be decreasing. This occurs because low implied volatility options will have a more dramatic change in Delta when the underlying moves. A high implied volatility underlying product will see less of a Delta change with movement as the possibility of more movement is foreseen.

(Source: OIC) 

Upcoming Economic Reports

A preview of what may move the market this week 

Options Insider Radio Network 

Episodes from the network exploring Gamma

Options Bootcamp 59; Going to the Dark Side with Second Order Greeks

Basic Trading: Second Order Greeks

• Question from Brian F. - My question is for Dan. I listened to the Boot Camp shows, and recently had a question about gamma. Imagine my surprise when I learned there are other secondary Greeks and even tertiary Greeks. What this? Are you holding some Greeks up your sleeve Mr. Black hat? So my question is what are these Greeks, but more importantly, who uses them and why? Does a retail mope like me need to know about these Greeks?
• Question from Charlie C. - Do second order Greeks have any relevance for retail traders?

Mail Call: Listener questions and comments

• Question from AV56 - When is a good time to start trading options - is there any certain time of the week or year that options traders are focused on?
• Question from 777: How do you adjust your options trading for cheap stocks below $10
• Comment from Brian F. - I went through the Options Bootcamp shows twice, and read a few books, and now have the bug for options. Have you perused the options videos on YouTube? Is it me, or are most of these people idiots? Thanks for the education on options, I now have a way to screen the real trading educators from the BS artists.
• Question from Max S. -I have a lot of AAPL in my IRA but I am worried about the downside potential going forward. I do not want to liquidate that position for a variety of reasons. I have some free capital in my trading account with TD. Does it make sense to potentially pick up a few AAPL puts in that account and use them as a hedge against the position in my IRA account? If I switch that trading account from TD to my IRA custodian will the firm treat those as offsetting positions? Thx for the show.
• Question from TJD - What is the story on using options in my IRA? Is it still legal for 2016?
• Comment from Matt L. - Huge fan of your shows, I have been binge re-listening to options bootcamp as I prepare for a new year of options trading, thanks!

Options Bootcamp 27: Calendar Spreads, the Sequel

Mail Call: So many questions, so many answers.

• Question from Alpha_Dog - Let's say I buy the Ford August Week 1 17 call, and then sell the July Week 4 17 call for a $.07 debit. How does that position make money? I don't get it. Don't both calls make/lose money as the stock goes up and down?
• Question from Nevin Pierce - What is more important when trading time spreads - gamma or Vega? Is Vega the source of profit and gamma the source of risk, or vise-versa? How do I profit of Vega without a corresponding large move that ends up costing me more with the gamma? Please help options drill instructors! I'm in over my head!
• Question from Tim Nettles - I am confused about time spreads. I don't really get how they work and how I'm supposed to view them. For example, in the XYZ July/Aug 50 call example cited my Mark Longo - what do I do after the July leg expires? Should I consider that or should I close out the whole position prior to July expiration? What if I was using the short leg to finance a longer term speculative play? Wouldn't it make sense then to leave the second leg on beyond the expiration of the first leg?
• Question from Ron Yueravich - On July 22, in FB, I will buy one Aug 23 put for $.32 and sell one weekly Week 1 July 26 call for $.16. I plan to sell the following after the short side expires - sell two Aug next week puts and then nine Aug 23 puts again. What do you think about this plan on Facebook? I feel there will be a little weakness in the stock before it climbs any higher. Thanks.
• Question from Mikos V - For John Critchley on Options Boot Camp - Does SOGO have any plans to alter the way they handle the margin for short time spread, to avoid the issue you cited where they are margined the same as naked short positions? This seems to waste a lot of capital and provide a disincentive to traders to take on these positions. Is there any way to provide better margin treatment, at least while the first leg of the trade is still active, or is that limited to portfolio margin clients only?
• Question from Emily Duncan, Fairfax, VA - So let me see if I have this straight - If I buy the Facebook Aug 26 call for $1.25, and I sell the July Week 4 26 call for $1.05. I've net paid a $.20 debit for a one month calendar spread. If Facebook rallies to 28 by expiration this week, I will have lost roughly $1 on my July calls and made about $.80 on my Aug calls. So I pretty much would have broken even, or am I completely off-base with my understanding of how this spread works?
• Question from Tim Anders - So if I have no bias and expect no movement, I should buy a time spread to profit from decay in the first month. Why not just short front month instead and save the hassle?

Options Bootcamp 23: Straddles 

Basic Training: Getting to know the fundamentals

• What is a Straddle? Why would you want to use it?
• Straddle pros and cons.
• Iron Butterflies and Iron Condors are straddles and strangles with protection.
• Gamma scalping is the only way to really make long straddles profitable over the long run.
• Exiting straddle positions is difficult to do effectively. Using straddles pre-earnings
• Scammers love to pitch straddles, saying "Make money in any market condition." Be careful.

Mail Call: Even bootcampers get mail privileges.

• Question from Alan Utchins, Baltimore, MD - I read with great interest the recent article about options trading in the New York Times. The article seemed to contradict everything you've discussed on this fine program. They highlighted several studies that they claimed prove that most options traders lose money. What is your response to this? Is this essentially a hit piece on the options market or does this author have some valid points?
• Question from Optrader - What books would you recommend about options trading (aside from Mr. Passarelli's, of course)?

Options Bootcamp 16: Avoid Earnings Pitfalls with Options 

Options Drills: How to play earnings through options plays. There are two basic approaches to earnings trading: long premium and short premium.

• Long Premium - PROS: Advantageous because you essentially receive free or dramatically reduced gamma with little decay in the weeks leading up to earnings. CONS: All of that decay comes out, and more, after the announcement. Also, much of the movement in the underlying occurs after-hours and is unavailable to options traders.
• Short Premium - PROS: Higher probability of success, need a substantial move post-earnings to lose money. CONS: Doesn't collect decay until earnings event, potentially losses can be catastrophic can make it hard to sleep at night.
• How to analyze Greeks during earnings week.
• Different strategies to employ during earnings: Calendars, Straddles, Strangles & Butterflies

Mail Call: Our drill Sergeants show their softer side.

• Question from Stock Doctor: Why can't I trade options after hours? I'm missing most of the stock movement if I wait until the next open.
• Question from Timothy Stephens, Tulsa, OK: If I buy a 3-month ATM calendar spread prior to earnings, am I correct in saying that I'm net long Vega and short gamma? If so, what type of earnings announcement would benefit me the most - an as-expected announcement where the stock stays at the ATM strike for my short gamma or a wildly unexpected announcement where the stock moves dramatically for my long Vega? Which risk metric is king in the time spread equation - gamma or Vega? Thank you very much for your insight and for producing this informative program.
• Question from Rich T: Does Sogo offer reduced commissions to close out short options trading for a nickel or less?

Options Bootcamp 8: It’s All Greek to Me

Basic Training: Time to revisit the Greeks:

• Delta - The chief Greek
• Gamma - The rate of change of Delta, as the underlying stock changes, but sometimes overwhelming to beginners.
• Theta - Time decay. The rate of change of an option given a change in the time to expiration.
• Vega - The king of the Greeks. The rate of change of an option price, as a result of change in implied volatility.

What is the difference between a retail and professional options trader?

Mail Call: Reaching out for a bootcamp lifeline.

• Tweet from Tex05: Mark, why do you always say that retail options traders trade Delta and professionals trade Vega?
• Email question from Evan - Atlanta, GA: Can you guys explain the importance of dividends to an options trader? That seems particularly important given the recent snafu over SPY dividends. Why are dividends important to options traders and how should it affect my options trading?
• Facebook question from Mike Debrasse: I'm hearing a lot about this being a "low volatility environment." Apparently, that makes it difficult for options traders. Why is that? Why does options volume drop so dramatically when volatility goes down? Should I wait to trade options before volatility/Vega goes up? Thanks for your help.

OICs Wide World of Options 52: Gamma Scalping 

Are you curious about what Gamma Scalping is and how you can use it as a part of your investment strategy? Host Joe Burgoyne has you covered as he welcomes Stan Freifeld of McMillan Analysis Corp who will discuss its trading methodologies. Also, Michael Thomsett, a prolific author of several options-related books, joins Joe for Profiles & Perspectives.

Advisors Option 57: Beware of Gamma and Flying Deltas

Options 101: Gamma: Measuring the Changes in Delta

• What is the relationship between gamma and Delta?
• What are the properties of gamma? What is put-call parity?
• At the money options and gamma? Out of the money options and gamma? Time and gamma?

The Buzz: The low volatility regime continues: 7 of the 11 days in the past 20 years where VIX has been below 10% have occurred since mid-May 2017. Two studies, two different conclusion about alts & hedge funds.

Office Hours: Listener questions and comments:

Advisors Option Flash Poll. With $VIX hitting new lows and $SPX new highs, what is your financial advisor telling you about using #Options?

• Write covered calls?
• Buy protective puts?
• Do Both - Use Collars
• They Won't Touch Options

Listener Questions:

• Question from LCB - Hey guys. You mentioned on the show that this is a challenging time to sell options due to low volatility. So does it stand that the opposite is true? Is it a good time to buy options? Particularly protective puts?
• Question from TIM D. - How high do rates need to be before I need to worry about rho?

Options Playbook Radio 179: The In-Between Greeks

It's time to tackle listener questions again on Options Playbook Radio. In this episode, Mark and Brian cover:

• Question from Albert Deckel - First, I want to thank you for all the effort you place into the options playbook. I find your lessons absolutely clear, understandable and instructive....a rare combination!! I bought your book and find that, also, clear and concise and very informative. Two questions: While I understand how to convert a "Delta" into meaning, I really don't understand what consists of a "high" vs. "low" Gamma, Theta or Vega. For example, when is theta so high that it makes the purchase of a contract dubious, or Vega so high that it makes the purchase of an OTM contract desirable? Also, if I were to write an ITM put, what combination of Delta, Gamma, Theta or Vega am I looking for? Thanks so much!! Al
• Question from Tim - Why isn't it standard or maybe required to let people close out shorts for free below $.10?

Options Playbook Radio 10: Meet the Greeks: Interrelatedness

For those of you with the book, we're on page 18, or look for "Meet the Greeks."

Today, Brian discusses:

• The interrelatedness of the Greeks
• The long straddle
• Volatility skew
• Looking at Delta first
• Analyzing Gamma
• Considering Theta
• And more

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