High Gamma describes an options position where the gamma value, a second-order derivative of the option’s price with respect to the underlying asset’s price, is significantly large. This condition implies that the option’s delta, which measures price sensitivity, will change rapidly with even small movements in the underlying asset.
Mechanism
In a high gamma position, a slight change in the underlying asset’s price causes a disproportionately large change in the option’s delta. This effect is most pronounced for at-the-money options nearing expiration. Market makers holding such positions face substantial hedging challenges, requiring frequent and precise adjustments to their underlying asset holdings to maintain a delta-neutral stance, thereby mitigating their exposure.
Methodology
Managing high gamma positions requires sophisticated algorithmic trading systems and real-time risk management protocols. Market makers employ dynamic hedging strategies, often involving continuous rebalancing of their spot positions as the underlying price fluctuates. The methodology aims to capitalize on the rapid delta changes for profit while simultaneously controlling increased transaction costs and slippage associated with frequent re-hedging.
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