Question

What is gamma risk? Suppose you were managing an option portfolio and had gamma risk. How would you get rid of gamma risk without incurring any other significant risk, at least for small market moves?

Answer 1

Gamma- It is the rate change in option's delta by 1 point if underlying asset moves. Gamma is positive in long positions and negative in short position.

Gamma risk- This is risk related to options in derivatives. It effects the in-the money option and out of the money option. If option is deep in the money or deep out of the money, Gamma will be smaller. When the option is near to expiry or At the money, Gamma is greater.

Get rid of Gamma risk- Gamma risk can be reduced by Delta hedge strategy. Delta hedging is hedging strategy that reduces risk related to price movements of underlying asset. It is done by offsetting long and short position.

Example: If investor has a long call position, he can take a short position in the same underlying stock.

Hedge ratio is the relationship between the change in option's theoretical value and change in price of underlying stock. Options with high hedge ratio is more profitable to buy.