Notice that as the option has now moved ITM, its Delta has moved above 0.5. So, the new Delta for a 5 point rise in the underlying is 0.6. How do we now calculate the new Delta? The New Delta can be calculated as 0.5 (Old Delta) + 0.02 (Gamma) * 5 (Change in the underlying price).
But, given that the underlying price has now changed and that the option has moved ITM, the Delta will also change. We had already seen such a calculation in the previous chapter, so nothing new here. Using this, we can calculate the new option price as ₹6 (Old Option price) + 0.5 (Delta) * ₹5 (Change in the underlying price).
In a few days, let’s say the stock price has risen to ₹105. Let us also assume that at present, this call option’s Delta is 0.5, Gamma is 0.02, and Option price is ₹6. Let us assume that a stock is currently trading at ₹100 and that we are looking at an ATM call option having a strike price of ₹100. To understand this, let us take a simple example. Where, Change in the underlying price = New underlying price - Old underlying priceįrom this, we can calculate the new value of Delta as: Put it in the form of an equation, Gamma can be expressed as:īecause we are interested in calculating the potential change in the value of Delta for a one point change in the underlying price, this equation can be rephrased as:Ĭhange in Delta = Gamma * Change in the underlying price
DELTA GAMMA IM ON A BOAT HOW TO
By understanding and tracking Gamma of options, one will know how to interpret the potential movement in Delta that could be caused by changes in the underlying price.And this is important because, depending on the value of Gamma, a trader can assess the changes in his position risk. Gamma is the rate of change in Delta for every 1 point move in the price of the underlying.While Delta measures the directional risk of an option, Gamma measures the changes in that directional risk. That is, Gamma is a derivative of a derivative, and hence is the second order derivative. Gamma, on the other hand, is the derivative of Delta.
As Delta is a derivative of option price, it is known as the first order derivative. This change can be measured using the Option Greek called Gamma. While Delta measure the change in option price for a change in the underlying price, the question that now arises is, is there a way to measure the change in Delta, given that Delta is not static?įortunately, there is. In other words, as there are changes in the underlying price, time to expiration, volatility, interest rates etc., the value of Delta will also change. However, as we highlighted at the end of the previous chapter, Delta is dynamic. We saw that using Delta, we can roughly estimate what the new option price could be for a certain point change in the value of the underlying. In the previous chapter, we saw why Delta is so crucial in the success of an option trade. So, without any further ado, let's get started. We shall first explain what Gamma means, before proceeding to its practical application.Having good understanding of Gamma would enable one to understand how changes in the underlying price impact the Delta(i.e directional risk) of an option, which intern influences the option price. In this chapter, we will continue our discussion from the earlier chapter and talk about the next Option Greek: Gamma. In this previous chapter, we talked in detail about Delta.
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