What Is Long Gamma and How Does It Affect Your Trades?

Options trading involves various metrics to assess potential outcomes and risks. Among these, “gamma” is a significant measure. This article explains long gamma, its meaning, and its influence on trading positions.

Options Fundamentals

An option is a financial contract granting the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined strike price on or before a specific expiration date. Call options provide the right to buy the underlying asset, while put options convey the right to sell it. The value of these options is influenced by the underlying asset’s price, time until expiration, and market volatility.

The price of an option does not move dollar-for-dollar with its underlying asset. Its sensitivity to price changes in the underlying asset is measured by delta. This sensitivity changes as the underlying asset’s price moves, which is where gamma becomes relevant.

Understanding Long Gamma

Gamma measures the rate of change of an option’s delta relative to a one-point movement in the underlying asset’s price. If delta tells you how much an option’s price changes for a given move in the underlying, gamma tells you how much that delta itself changes. For instance, if an option has a delta of 0.50 and a gamma of 0.05, a $1 increase in the underlying asset’s price could cause the delta to increase from 0.50 to 0.55. This means the option’s price would then be expected to move $0.55 for every subsequent $1 move in the underlying.

A “long gamma” position indicates that you own options, whether they are calls or puts. This type of position benefits from significant price movements in the underlying asset, regardless of direction. As the underlying asset’s price moves further away from the option’s strike price, the delta of the owned option typically increases in magnitude. This accelerated change in delta is a core characteristic of a long gamma position, allowing it to capture larger gains from volatile price swings.

Long gamma means your delta exposure increases as the underlying asset moves favorably in your chosen direction. For example, if you own a call option and the underlying asset’s price rises, your delta will increase, making your position more sensitive to further upward movements. Conversely, if you own a put option and the underlying asset’s price falls, your delta will become more negative, making your position more sensitive to further downward movements. This dynamic allows long gamma positions to profit from large and rapid shifts in the underlying asset’s price.

How Long Gamma Positions Behave

Long gamma positions exhibit a non-linear relationship with the underlying asset’s price. Their value accelerates with favorable price changes and decelerates with unfavorable ones. This means long gamma positions are “long volatility,” benefiting when the underlying asset experiences significant price swings, whether up or down. The greater the magnitude of the price movement, the more pronounced the benefit to a long gamma position.

A key consideration for long gamma positions is their relationship with time decay, also known as theta. Long gamma positions typically have negative theta, which means they lose value as time passes, assuming the underlying asset’s price remains unchanged. This time decay represents the cost of maintaining a long gamma exposure; it is the premium paid for the potential benefit of large price movements. The profit potential from favorable price movements must be substantial enough to offset this continuous erosion of value due to time passing.

The benefit of holding a long gamma position comes from its ability to capture substantial gains during periods of high volatility. If the underlying asset makes a significant move, the increasing delta of the option allows the position to participate more fully in that movement. This accelerated participation can often outweigh the negative impact of time decay, especially if the move occurs quickly. Traders holding long gamma positions are essentially betting on significant price volatility to realize profits.

Managing long gamma positions involves balancing the desire for large price movements against the continuous drag of time decay. While a long gamma position profits from volatility, it is sensitive to the speed and extent of those movements. If the underlying asset remains stagnant or moves only slightly, the eroding effect of negative theta will gradually diminish the option’s value. This makes long gamma positions speculative bets on future price dislocations rather than steady, income-generating strategies.

Common Long Gamma Positions

Several common options structures possess a long gamma profile. One of the simplest ways to achieve long gamma is by purchasing a single call option. When you buy a call, you own the right to buy the underlying asset, and as the underlying price moves, your delta will change, demonstrating positive gamma. Similarly, purchasing a single put option also results in a long gamma position, as you own the right to sell the underlying asset, and its delta will also accelerate in magnitude with price movements.

Another popular structure for obtaining long gamma is a long straddle. This involves simultaneously buying both a call and a put option with the same strike price and expiration date on the same underlying asset. This position benefits from large moves in either direction because you own both options, and their combined deltas will increase as the underlying moves significantly away from the common strike. The objective is to profit from a substantial price movement, regardless of its direction, which is characteristic of long gamma.

A variation of the long straddle is the long strangle, which also provides a long gamma exposure. A long strangle involves buying an out-of-the-money call option and an out-of-the-money put option with the same expiration date. This position benefits from significant price swings in the underlying asset, but it requires an even larger move to become profitable due to the options being further out-of-the-money. In both straddles and strangles, the ownership of the options is what confers the long gamma characteristic, allowing the position to gain sensitivity to large price changes.