# Gamma Hedging Explained: Understand, Implement, and Compare With Delta Hedging

## What Is Gamma Hedging?

Gamma hedging is a trading strategy that tries to maintain a constant delta in an [options](https://www.investopedia.com/terms/o/option.asp) position, often one that is delta-neutral, as the underlying asset changes price. It is used to reduce the risk created when the underlying security makes strong up or down moves, particularly during the last days before expiration.

An option position's [gamma](https://www.investopedia.com/terms/g/gamma.asp) is the rate of change in its [delta](https://www.investopedia.com/terms/d/delta.asp) for every 1-point move in the underlying asset's price. Gamma is an important measure of the convexity of a [derivative's](https://www.investopedia.com/terms/d/derivative.asp) value, in relation to the underlying asset. A [delta hedge](https://www.investopedia.com/terms/d/deltahedging.asp) strategy, in comparison, only reduces the effect of relatively small underlying price changes on the options price.

Gamma hedging is sophisticated and necessary for advanced options trading, particularly near expiration.

### Key Takeaways

*   Gamma hedging aims to stabilize the delta of an options position, reducing risks associated with large price shifts in the underlying asset, especially as expiration nears.
*   Unlike delta hedging that protects against small price changes, gamma hedging adds a layer of protection against significant price changes by adjusting delta.
*   Combining delta and gamma hedging can offer comprehensive protection, ensuring that an options position remains secure even with substantial market movements.
*   Gamma’s role is crucial in measuring the change in delta as the underlying asset’s price shifts, providing insight into options price stability.
*   Traders often employ a mix of delta and gamma hedging to guard against both small and large price fluctuations while considering both immediate and further-reaching impacts on their options positions.

## Understanding the Mechanics of Gamma Hedging

A [gamma neutral](https://www.investopedia.com/terms/g/gammaneutral.asp) options position is one that has been immunized to large moves in an [underlying security](https://www.investopedia.com/terms/u/underlying-security.asp). Achieving a gamma neutral position is a method of managing risk in options trading by establishing an asset portfolio whose delta's rate of change is close to zero, even as the underlying rises or falls. This is known as gamma hedging. A gamma-neutral portfolio is thus hedged against second-order time [price sensitivity](https://www.investopedia.com/terms/p/price-sensitivity.asp).

Gamma hedging consists of adding additional option contracts to a portfolio, usually in contrast to the current position. For example, if a large number of calls were being held in a position, then a trader might add a small put-option position to offset an unexpected drop in price during the next 24 to 48 hours, or sell a carefully chosen number of call options at a different strike price. Gamma hedging is a sophisticated activity that requires careful calculation in order to be done correctly.

## Comparing Gamma and Delta: Key Differences Explained

Gamma is the Greek-alphabet inspired name of a standard variable from the [Black-Scholes Model](https://www.investopedia.com/terms/b/blackscholes.asp), the first formula recognized as a standard for pricing options. Within this formula are two particular variables that help traders understand the way option prices change in relation to the price moves of the underlying security: delta and gamma.

[Delta](https://www.investopedia.com/terms/d/delta.asp) tells a trader how much an [option's](https://www.investopedia.com/terms/o/optionscontract.asp) price is expected to change because of a small change in the underlying stock or asset—specifically a one-dollar change in price.

Gamma refers to the rate of change of an option's delta with respect to the change in the price of an underlying stock or other asset's price. Essentially, gamma is the rate of change of the price of an option. However, some traders also think of gamma as the expected change resulting from the second consecutive one-dollar change in the price of the underlying. So that by adding gamma and delta to the original delta, you'd get the expected move from a two-dollar move in the underlying security.

## Combining Delta and Gamma Hedging Strategies

Delta-gamma hedging is an options strategy that combines both delta and gamma hedges to mitigate the risk of changes in the underlying asset—and also in the delta itself—as the underlying asset moves. With delta hedging alone, a position has protection from small changes in the underlying asset. However, large changes will change the hedge (change the delta), leaving the position vulnerable. By adding a gamma hedge, the delta hedge remains intact.

When using gamma and delta hedges together, investors must adjust hedges as the underlying asset's delta changes. In a delta-gamma hedge, the number of shares bought or sold depends on the asset's price direction and size of change.

A trader aiming for [delta-neutrality](https://www.investopedia.com/terms/d/deltaneutral.asp) usually makes trades that react minimally to small, short-term price changes. A trader who is trying to be delta-hedged or [delta-neutral](https://www.investopedia.com/terms/d/deltaneutral.asp) is usually making a trade that has very little change based on the short-term price fluctuation of a smaller magnitude. Such trades often bet that [volatility](https://www.investopedia.com/terms/v/volatility.asp), or demand for the options, will rise or fall significantly. But even delta hedging will not protect an options trader very well on the day before expiration. On this day, because so little time remains before expiration, the impact of even a normal price fluctuation in the underlying security can cause very significant price changes in the option. Delta hedging is therefore not enough under these circumstances.

Gamma hedging is added to a [delta-hedge](https://www.investopedia.com/ask/answers/071715/what-are-common-delta-hedging-strategies.asp) to guard against big security changes, especially when options are near expiration.

> **Important**
>
> Traders often aim for a delta-gamma hedge that is delta-neutral, yet some prefer maintaining specific delta positions—positive, negative, but gamma neutral.

## Gamma Hedging vs. Delta Hedging: A Comparative Analysis

As we have seen above, delta- and gamma-hedging are often used together. A simple delta hedge can be created by purchasing call options and shorting a certain number of shares of the [underlying](https://www.investopedia.com/terms/u/underlying-asset.asp) stock at the same time. If the stock's price remains the same, but volatility rises, the trader may profit unless time value erosion destroys those profits. A trader could add a short call with a different [strike price](https://www.investopedia.com/terms/s/strikeprice.asp) to the strategy to offset time value decay and protect against a large move in the delta; adding that second call to the position is a gamma hedge.

As the underlying stock rises and falls in value, an investor may buy or sell shares in the stock if they wish to keep the position neutral. This can increase the trade's volatility and costs. Delta and gamma hedging don't have to be [completely neutral](https://www.investopedia.com/articles/optioninvestor/07/gamm_delta_neutral.asp), and traders may adjust how much positive or negative gamma they are exposed to over time.

## The Bottom Line

Gamma hedging is an options strategy aimed at maintaining a constant delta to manage risks associated with significant price movements in the underlying asset, especially as expiration nears. A complementary relationship exists between delta and gamma hedging. They're used together to provide a more comprehensive risk management strategy by protecting against both small and large underlying price changes.

Precise calculation and careful execution are necessary in gamma hedging, so it's suited for experienced traders. It's important to understand the trade-offs between using these strategies and the potential increase in volatility and trading costs when maintaining a hedged position. They can manage risk, but they don't guarantee profits, and they involve their own set of risks that need careful consideration.

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