Gamma Neutral
A gamma neutral options position is one that has been immunized to large moves in an underlying security. Achieving a gamma neutral position is a method of managing risk in options trading by establishing an asset portfolio whose delta's rate of change is close to zero even as the underlying rises or falls. This is known as gamma hedging. A gamma-neutral portfolio is thus hedged against second-order time price sensitivity.Gamma is one of the "options Greeks" along with delta, rho, theta, and vega. These are used to assess the different types of risk in options portfolios.
Gamma Neutral
Definition
Gamma neutral refers to an options position that remains immune to significant fluctuations in the underlying security. Achieving a gamma neutral position is a method of managing options trading risk by constructing a portfolio where the rate of change of the portfolio's delta is close to zero, regardless of whether the underlying asset rises or falls. This is known as gamma hedging. Gamma is one of the 'Greek letters' in options trading, which also includes delta, rho, theta, and vega. These are used to assess different types of risks in an options portfolio.
Origin
The concept of gamma neutrality originated with the development of the financial derivatives market, particularly in options trading. As the complexity of the options market increased, traders needed more sophisticated risk management tools. In the 1970s, with the introduction of the Black-Scholes model, options pricing theory advanced significantly, and gamma neutrality became widely used as an advanced risk management strategy.
Categories and Characteristics
Gamma neutral strategies are mainly divided into two categories: static gamma neutral and dynamic gamma neutral. Static gamma neutral refers to achieving gamma neutrality at the time of position establishment, while dynamic gamma neutral requires continuous adjustment of positions to maintain gamma neutrality.
- Static Gamma Neutral: Suitable for short-term trading, lower initial cost, but requires precise market predictions.
- Dynamic Gamma Neutral: Suitable for long-term investment, requires frequent position adjustments, higher cost, but more effective risk management.
Specific Cases
Case 1: Suppose an investor holds a call option and a put option, adjusting the quantities of these two options to make the overall portfolio's gamma value zero. This way, regardless of how the underlying asset price fluctuates, the change in the portfolio's delta is minimal, achieving risk hedging.
Case 2: An investor holds a large number of stocks while simultaneously selling a corresponding number of call options and buying put options to achieve gamma neutrality. Even if the stock price fluctuates significantly, the investor's overall risk is effectively controlled.
Common Questions
Q: Does a gamma neutral strategy completely eliminate risk?
A: A gamma neutral strategy primarily hedges second-order price sensitivity but does not completely eliminate all risks, especially market liquidity risk and extreme market volatility.
Q: What are the costs involved in achieving gamma neutrality?
A: Achieving gamma neutrality requires frequent position adjustments, which incur transaction costs. Additionally, inaccurate market predictions may lead to extra adjustment costs.
