Understanding Gamma in Options Trading

In the Indian options trading platform, one of the key terms to be known includes "Greeks"; this includes gamma, one of the most important terms whose metric shows the level of sensitivity the option has towards changes in the price of the stock at which it is underlined. Now let's have a step-by-step understanding of gamma and how it goes with the Indian market. 

What is Gamma?

Gamma measures how much the delta of an option changes with a Rs one move in the underlying stock. Let's break this down using an example: 

• Delta tells you how much the price of the option will alter if the stock price moves one Rupee. 
• Gamma tells you how much the delta itself would change if the stock price were to move one Rupee.

Think of delta as the "speed" of an option's price movement and gamma as the "acceleration" of that speed. Gamma tells you how stable or volatile the price sensitivity is, given that the stock moves.

Why Gamma Matters to Indian Traders:

Gamma is particularly useful for Indian traders because of these reasons:

1. Gamma price sensitivity forecast: Gamma predicts how fast the option price will change when equities like NIFTY50 or SENSEX change.

2. Risk Management: Through gamma, the risk management for Indian traders particularly those on high-volume strategies is addressed. High-gamma options are most sensitive to price movement where the change may reflect bigger profits or losses in case of changes in the market.

3. Volatility at the Expiry Date: The Indian market usually throws up surprisingly volatile levels when options are reaching close to expiry dates. Gamma spikes in such scenarios, particularly when options are close to expiry dates, especially close to expiration dates for options that are 'at-the-money.' It makes gamma highly crucial for the trader, so they can catch on very quickly to price changes.

Gamma for Indian Options in Action:

Let's get an example using an Indian stock option. Suppose you buy a call option on Reliance Industries that is trading at ₹2500 with a strike price of ₹2500-at-the-money. Assume this option has a delta of 0.5 and a gamma of 0.1.

If the stock price of Reliance goes up by ₹1, because the gamma of Reliance is 0.1, the delta of your option will move up from 0.5 to 0.6. Now, your option is more sensitive than you were before to the price moves because it responds even more strongly to the next price move too. When the price goes up or down by ₹1 again next time, its delta will further jump from 0.6 to 0.7.

Key Takeaways for Gamma in India :

1. Gamma is highest when Options are At-the-Money: The options that are closest to the stock price, or "at-the-money," have a high gamma, meaning they will respond most sharply to the stock's movements.

2. Low gamma for In-the-Money and Out-of-the-Money Options: Options with strike prices much higher or lower than the stock price have lower gamma, with a delta that is less sensitive to small movements in the stock.

3. Gamma Spikes Near-Expiry: Options close to expiry in India- like in weekly expiry options in the NIFTY and BANKNIFTY- have higher gamma, which makes them more volatile and prone to stock movements. Therefore, this is an important factor for Indian market traders who broadly follow weekly expiry options.

4. Delta Hedging: Many Indian market traders, whether it is a broker or an institutional trader, use gamma in adjusting delta hedging to balance their respective books by managing risks as stock prices fluctuate.

5. Short-Term Trading Opportunities: High gamma options which are closer to expiration dates such as NIFTY and BANKNIFTY thus open scope for short-term trading that would yield a massive return but has a higher risk profile.

6. Management in the volatile Indian market: A huge announcement by a company in the index or major economic activity to take place can cause massive changes in the market direction at one instance causing turbulence. Then Gamma will reveal just how sensitive a particular trading position might be towards abrupt changes in price due to its volatility.

Final Thoughts for Indian Traders

Gamma represents opportunities in the Indian options market and, therefore, is highly crucial to understanding as well as how to handle risk management well during fluctuation.