What is Gamma Exposure in Stocks?
When trading stock in the market, you should try to find a reliable edge, so you know when and why market participants must sell or buy assets.
Many people just buy and sell stocks through a broker, but for people who do options trading, it is important that they know how options trading is done and how Gamma Exposure is used.
Gamma Exposure (GEX) and Gamma have become increasingly important.
Due to these forces, traders must buy and sell to get reliable behavior. One of the hidden market forces is Gamma Exposure.
Gamma Exposure involves price sensitivity of derivatives to price changes in an underlying security. A huge factor in movements in the stock markets are when market makers are trading options to and from the traders.
To do this, they are compelled to hedge their risks in a process called Delta Hedging.
Gamma Exposure is sometimes called dollar gamma and it measures second order pricing sensitivity of an option to changes in the price of an underlying asset.
Google defines the Gamma Exposure formula as “the Total Gamma Exposure (GEX) for each strike by multiplying each option's gamma, for all the calls and puts, by their respective Open Interest.
After multiplying them by 100 as each option represents 100 shares. For the puts, multiply each by -1 as their gamma is negative.”
Gamma measures how much the delta moves if the underlying assets move. When this happens the participants in the market would act to offset these changes by trading the underlying assets.
Gamma Exposure: Delta Hedging
When market makers and traders trade options, they must hedge their risks by buying and selling the underlying security of the underlying security in a process called Delta Hedging.
When hedging, the delta changes based on how far the delta is from the underlying securities price from the stock option’s strike price and the rate of sensitivity changes, a rate change known as the Gamma.
The price of the security changes as the dealers adjust their hedge through buying and selling of additional stock, so that their positions are neutral.
Gamma Hedging is used to adjust a Delta Hedge in relation to the underlying security’s price. Constant buying and selling counters the markets direction due to Gamma Hedging and this can cause a decrease in volatility.
Gamma Hedge is a trading strategy used to try to keep the constant delta in an options position, usually delta-neutral. The Gamma is a change rate in the delta for each one point move in the underlying security’s price.
Gamma Exposure: Gamma Hedging
Gamma Hedging is a strategy used in options trade to reduce the options exposure to huge movements in the underlying asset. It is used with an options’ expiration to protect against rapid changes in the underlying securities price which can happen as the time of expiration nears.
Gamma Exposure: Zero Gamma
Long and short gamma are required to help manage market volatility and in the process reaches a point called the Zero Gamma level.
This Zero Gamma level generally causes the support level for the price of the securities to achieve a balance caused by the selling and buying from the dealers.
In order to find the Zero Gamma exposure for puts and calls, we need to find the total Gamma Exposure.
An overview of long and short and short gamma values.
Gamma options estimate an option’s delta rate of change as the stock price fluctuates.
This option delta provides the estimated option price change in relation to a dollar’s change in the price of the stock.
The delta measures the direction of the risk exposure.
The gamma option provides you with how that delta will move as the price of the stock changes, so we would know the direction of the risk exposure as the stock price fluctuates.
Knowing about the gamma is critical in options trading.
This is because traders use a delta hedge and closely watch the gamma, because it tells them how their delta position will change when there are changes in the stock price.
A high gamma value means there will be high volatility in the direction of the risk exposure, as a high gamma will move the delta when the stock moves.
Low gamma value means low volatility in relation to the direction of risk exposure. Thus, if the option has low volatility, hence a low gamma, the delta will only have a small change when the stock moves.
This means that traders will find it difficult to delta hedge with a high gamma option than with a low gamma option exposure. This lets you understand how the profit and loss sensitivity changes when the price of stocks changes.
Gamma Exposure: Long Gamma
A long gamma position provides positive gamma exposure indicating that the delta increases as the stock price increases and decreases when the price of the stock falls.
When you buy a put with positive gamma exposure, that gamma will be added to the delta as the stock price rises and subtracted from the delta as the stock price falls.
Thus, the local put or call position turns more positive and less negative as the stock price increases. The position will turn more negative and your calls and puts turn more negative, when the stock price becomes lower.
Long gamma positions improve as stock prices move favorable towards those positions, due to the exposure direction as the position moves in the same direction as the price of the stock.
A long call trader would like the stock prices to increase in profit due to the increasing positive exposure of the delta.
Conversely, a long put or long call delta position would fall as the price of stock falls.
Gamma Exposure: Short Gamma
If your gamma has negative exposure, it has a short gamma position. This shows that the delta’s position decreases as the stock price increases and there is an increase as the price of the stock declines.
Short puts and short calls positions provide negative gamma. If your put or call is short, the gamma is subtracted from the delta position as there is an increase in the stock price and added to the delta position as the stock price falls.
Short gamma are positions with negative gamma. These short gamma positions are harmed as the stock prices move against the position due to the position’s direction exposure, as it moves in the direction due to the movement of the stock prices.
If you are a short put trade you would not want the price of the stock to decline, as your losses will become worse if the stock price declines.
The intention of this article is not to magically turn you into a stock broker, so you can buy and sell options. However, by showing you the basics of Gamma Exposure, you might feel a bit more confident when you buy and sell stocks.