Gamma hedging strategies are employed to manage the second-order risk exposure of an options portfolio, specifically the sensitivity of the portfolio’s delta to changes in the underlying asset’s price. Gamma risk increases significantly as an option approaches expiration or when the underlying asset’s price nears the strike price. Effective gamma management is essential for maintaining a delta-neutral position and mitigating potential losses from rapid price movements.
Adjustment
The core of gamma hedging involves dynamically adjusting the position in the underlying asset to counteract changes in delta. This adjustment process requires frequent buying or selling of the underlying asset to maintain the desired risk profile. The frequency and size of these adjustments are determined by the portfolio’s gamma exposure and market volatility.
Volatility
Market volatility directly influences the effectiveness and cost of gamma hedging strategies. Higher volatility increases gamma exposure, requiring more frequent and larger adjustments to maintain neutrality. This dynamic relationship means that hedging costs rise during periods of high market turbulence, impacting the profitability of options trading strategies.
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