Understanding Long and Short Gamma

Focus: Options

Adam Warner Image Adam Warner Author, Options Volatility Trading

I often mention the option Greek gamma, and refer to "long gamma" or "short gamma" when describing a position. I bet many of you wonder what exactly that means, and/or how to manage said position. So I'll explain.

Gamma is used to measure the rate of change in an option's delta as the underlying security (stock, ETF, index) moves. In a positional context, long gamma means your option position is such that if the stock rallies (or declines), your share equivalent position (also known as delta) gets you longer (or shorter).

Example of a Long Gamma Position

Let's say you own 1,000 shares of Apple (AAPL) and you own 20 AAPL Feb 210 puts.

With AAPL trading around $210, your 210 puts have roughly a 50 delta. That means that each put you own is the equivalent of being short 50 shares of stock. So, right here, right now, owning 20 puts is the share equivalent of shorting 1,000 shares of AAPL. Since I am physically long 1,000 shares of AAPL, my share equivalent position is 0, or flat.

But let's say AAPL rallies. The share equivalent (delta) position of my puts declines. For arguments sake, let's say they now have 40 delta, making me equivalent to short 800 shares via the puts (40 x 20). My stock position obviously stays the same at 1,000 shares, making my net position the equivalent of long 200 AAPL shares (1,000 - 800).

Conversely, had AAPL declined a similar amount, and the delta of the puts increased to 60, I'd be the equivalent of short 200 AAPL shares (60 x 20) - 1,000.

That's a long gamma position.