Long Gamma vs Short Gamma: Options Strategy Explained – SteadyOptions Trading Blog

At first glance, gamma might appear to be just another intriguing metric, akin to those hyper-specific statistics sports announcers love to cite. For example, “This quarterback throws interceptions twice as often when targeting defensive backs whose last name starts with a ‘B.'” Interesting, but does it hold any real significance?

However, the gamma of an options position has substantial implications for how profit and loss (P&L) will evolve over the life of that position. Positions with positive gamma exhibit very different characteristics compared to those with negative gamma.

To provide some context, Goldman Sachs stated:

A trader is considered long gamma when their options position has positive gamma, which typically involves being net-long options.

Most non-professional options traders operate within the positive gamma realm. Common examples of long gamma trades include outright long calls or puts and vertical debit spreads.

As a general rule, long gamma positions are often short theta, meaning they experience the negative carry of theta decay.

Consequently, long gamma positions thrive in strong trending markets, while they may see a gradual decline in P&L during sideways, range-bound markets due to theta decay.
 

In contrast to short gamma positions, your total exposure in a long gamma position increases when you are correct in your trade. For instance, if you are long a call (a favorable gamma position), your deltas will rise as your trade moves in your favor.

This aspect of long gamma positions makes them significantly easier to manage than short gamma positions. It’s psychologically simpler to handle positions when your exposure only grows if you are already making money. Provided you size your positions appropriately, you won’t have to worry about them spiraling out of control. And when you are right, the rewards can be substantial.

If you’ve participated in online options trading discussions on platforms like Twitter and Reddit, you may already be familiar with short gamma positioning, which is often linked to the phenomenon known as the ‘gamma squeeze.’

A short gamma position is characterized by being net-short options, encompassing all the benefits and drawbacks of selling options. This position carries negative gamma exposure.
 

A position with negative gamma indicates that the delta will decrease when the stock price rises and increase when the stock price falls. Short call and short put positions are examples of negative gamma.

Specifically:

• Benefits from low volatility and sideways price action
• Exposure grows in the wrong direction (your position gets larger when you’re incorrect)
• Typically exhibits concave payoff profiles (limited gains for potentially larger losses)
• Vulnerable to “gamma squeezes.”
• Benefits from theta decay

A gamma squeeze is a distinct topic from evaluating the pros and cons of gamma levels in your options positions, but explaining it can highlight the power of gamma.

A gamma squeeze occurs when an excessive number of traders, primarily market makers, find themselves in a short gamma position during a sudden increase in market volatility. This forces market makers to rapidly adjust their delta hedges, further fueling the rally and creating a feedback loop.

Essentially, options traders have deduced two key points about option market makers:

• They are often short gamma
• They systematically delta hedge

The logical follow-up is that if a rapid price movement occurs while market makers are heavily short gamma, their hedging response will create a feedback loop, continuously pushing the price in the direction of the trend.

Here’s how this theoretically unfolds:

• Market makers are generally short gamma and short options because customers tend to be long options for hedging and speculation.
   
• This tendency is amplified in stocks favored by retail traders who often buy out-of-the-money (OTM) calls, which have high gamma, leading market makers to become very short gamma.
   
• When a catalyst triggers a surge in call buying, the rapid price movements in the underlying force market makers to adjust their delta hedges, further fueling the rally and creating a feedback loop.
   

How Expiration Impacts Gamma

Gamma is typically higher for options that are at-the-money and closer to expiration. A front-month option will exhibit more gamma than a LEAPS option with the same strike because the delta of near-term options is more likely to move toward either 0 or 1.00. With increased gamma, investors can witness more dramatic shifts in delta as the underlying moves, especially when the underlying is near the strike at expiration.

Gamma is lower in longer-dated LEAPS since more strikes remain viable for being in-the-money at expiration due to the extended time frame. An at-the-money option’s delta is typically the most sensitive to moves in the underlying, resulting in higher gamma. When the stock is right at a strike at expiration, the option’s gamma peaks as the delta can rapidly shift from 1.00 toward 0 or vice versa as the underlying crosses a strike. In these scenarios, gamma can be exceptionally high as the delta changes swiftly with the underlying at the strike and expiration approaching.