13 Minute Read

Tales of a Technician: Sir Gamma, a Gentleman

June 8, 2016

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Tales of a Technician: Sir Gamma, a Gentleman (illustration by Tyler Craig)

Today I attempt a dangerous feat. Don’t try to stop me. My course is set, the die is cast. We’re venturing into the wonky world of the Greeks. One teeming with mundane minutia and sleep-inducing theory. The kind requiring your head remain stable whilst digesting lest anything fall out. Not too worry, though. I just polished off the final session of my latest Options 2 course wherein wise queries and enlightening answers littered the landscape. And while the din of the audience has long subsided my desire for creative expression with a financial bent has yet to abate.

Lucky for you the all-star pupils in attendance tonight were as engaged as ever making me up my performance and bring out the big guns. You know, the best analogies and metaphors for option concepts. Those boasting a 99% guarantee of confusion eradication.

One which I mentioned in passing but didn’t have the time to do justice was a get to know you of sorts for my pal, Gamma. See, when introducing each of the strategies in our Options I and 2 courses (covered calls, calendars, risk-reversals, and the like) we have a slide that covers the Greeks in all their glory. It places the personality traits, the idiosyncrasies of each strategy, in plain view for all to behold.

The first two Greek traits receive the limelight. They’re relatively easy to understand, straightforward in nature, leaving little room for obfuscation. No doubt you’ve heard of them by now – delta and theta.

For sake of time as well as to save neophyte option traders from information overload we typically gloss over gamma. Today we give him his due.

The goal? Why, to entertain and enlighten, as always. My trick? I’ll anthropomorphize gamma, regal you with stories about the little known benefactor accompanying you on all your option buying adventures.

Rest assured you’ll love him and depart today wanting more stories.

Sir Gamma is a modern day Jekyll and Hyde character. Today we focus on his benevolent side, one positively bursting with gifts. To acquire his good graces you need merely buy an option – call or put. Built into each long option is automatic access to what the Greek geeks among us call “positive gamma”. Consider it code for Sir Gamma’s Jekyll side.

And what, pray tell, does the venerable gentleman provide you? Why, he accelerates your gains when your option turns out a winner. It’s tantamount to dousing the flames of profit with gasoline. In short, he is the reason behind the explosive profits that await all option buyers.

But he doesn’t stop there, no. In a past life Sir Gamma suffered failure after failure. He knows the pain of loss and in one fateful fit of rage he covenanted with the market gods that his next life would be dedicated to assuaging the grief of others.

That easing of pain comes in the form of dampening losses for option owners. The more unruly the underlying becomes, the more Gamma works on your behalf to stem the losses.

He is, as I said, a kindly gentleman.

Suppose, like me, you bought puts a few weeks ago when Apple sliced below major support at $92.50. Let’s say you purchased an at-the-money put boasting a delta of -0.50. That means initially you make $50 for every $1 drop in AAPL.  Now, enter Gamma. As the stock drops and your put moves in-the-money Gamma will increase your rate of gain to $60 per $1 drop, then $70 per $1 drop, then $80 per $1 drop, so on and so forth.

His generosity does have limits, however. Once he ramps your rate of gain to $100 for every $1 drop in AAPL, he departs in search of some other wanting fellow.

Now, what if AAPL had rallied instead of dropped? Initially your -0.50 delta put would have delivered a $50 loss for every $1 gain. Swiftly, however, Gamma, that empathetic gentleman that he is, would have swooped in to ease your burden. As the stock rallied placing your put further out-of-the-money Gamma would decrease your rate of loss to $40 per $1 gain, then $30 per $1 gain, then $20 per $1 gain, so on and so forth.

Eventually the rate of loss would fall to zero, Gamma would declare victory, and your mind would be put at ease knowing that dastardly AAPL stock has been rendered impotent.

The invisible hand of Gamma is revealed in the risk graph of your put option. Behold:

gamma hands

Now, imagine a Gamma-less world. One where gains rack up at a linear rate and losses just keep on coming. Without Gamma explosive upside dies; the acceleration of profits doesn’t exist. Worse yet, the pain from losses just keeps on coming. Day after day, dollar after dollar. In such a world traders are left to fend off losing trades themselves. *shudder*

Want to see what a sad, deplorable position lacking any of Sir Gamma’s magic looks like? Hide the kids and feast your eyes on this:

Long Stock

‘Tis a graph sans curves. That right there is a long stock trade. Poor saps don’t even know Sir Gamma exists.


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11 Replies to “Tales of a Technician: Sir Gamma, a Gentleman”

  1. KEITHGIUNTA says:

    Thanks, Tyler, for clarifying.

  2. JoanNee says:

    Love this! I definitely don’t get the Greeks yet, and how they impact options, so I appreciate the lesson.

  3. Nicholas Kingsbury says:

    Keep up the good work.

  4. Thomas Hammonds says:

    Thanks Ty!!

  5. Chris Latimer says:

    Thank you Tyler for putting gamma in another perspective. Now I get it!

  6. FrancesK says:

    That was a fun way to learn about Gamma. Thanks!

  7. Paul Seward says:

    Does Dr. Jekyll turn into Mr. Hyde when you sell those options?

  8. Rani Bush says:

    Yes, please enlighten us on Gamma’s Mr. Hyde side as well as you did for his Dr. Jekyll side! Maybe in a future article. Thanks.

  9. TylerCraig says:

    Paul/Rani. Indeed, he has a Hyde side. I’ll put that on the to-do list.

  10. DanielBrodhead says:

    I love Sir Gamma!!

Comments are closed.

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