Gamma Risk II

Positive (or "long") gamma manufactures positive deltas when the stock goes up and negative deltas when the stock goes down. If you were short that SPY 127 call, all the numbers are reversed. The delta on the short call position is -.45 and the gamma is -.11. As the SPY rallies, your negative delta, or short stock equivalent position, increases. You lose more than you would on the original stock equivalent position. If the SPY falls, your negative delta decreases. You make less than you would on the original stock equivalent position. That’s what I mean when I say that short gamma manufactures “bad” deltas. Negative (or "short") gamma manufactures negative deltas when the stock goes up and positive deltas when the stock goes down. Because gamma manufactures delta, the gamma of a position explains how stable the delta is. That is, if gamma is low, either positive or negative, when the stock price changes the delta of the position doesn’t change much. In that case, if you are comfortable from a risk perspective with the delta of your position and the gamma is low, you can be pretty confident that even if the stock price changes, the delta exposure won’t change much. Positions with low gammas tend to be things like verticals that aren't close to expiration. But if gamma is high, a small change in the stock price can generate a big change in the position’s delta. Now, the gamma of an option is sensitive to whether the option is at the money or away from the money, how close it is to expiration, and changes in implied volatility. Gamma increases when the option is at the money, the option is close to expiration or volatility is low. Gamma decreases when the option is away from the money, the option is far from expiration or volatility is high. So, if you have an option position, its gamma can (and probably will) fluctuate. Let’s say you have a long SPY Jan/Feb 126 call calendar spread. The delta of one of 10 of those spreads is +9, and the gamma is -40. The negative gamma of the position indicates that the delta of +9 can turn into +49 deltas if SPY drops -1.00 or -31 if SPY rallies 1.00. Now, those numbers aren't precise because gamma is most accurate for very small (.01) changes in the stock price. But gamma is commonly used as a 1.00 point measure. The SPY can move 1.00 in a day, and can easily do it in two or three days. So, if you are comfortable with the +9 delta of the position now, that could change pretty quickly.