In the world of options nothing confuses people more than the Greeks. What’s more, within the Greeks nothing confuses traders more than the relationship between delta and gamma. For some reason many traders have a lot of trouble separating the signs of delta and gamma. It seems that many traders can’t get passed that fact that a short delta can have long gamma. Yesterday, I was working with a newer option mentoring student discussing the relationship between gamma and delta. I’ll share the conversation I had with him that helped him understand the delta gamma relationship.
Gamma and Delta are COMPLETELY independent of each other. Think about delta and gamma in terms of a cars and trucks. In our example the speed the actual car is going is delta and acceleration or breaking is gamma.
I know it sounds simplistic, if a car is moving 60 miles an hour, set to cruise control, as long as the driver does not touch the cruise settings the car will continue to move 60 miles an hour. If an hour goes buy (think a 1 point upward move in stock price) the car will moved forward 60 miles. If the car is moving 20 miles an hour in reverse and an hour goes by, the car will have moved backward 20 miles.
Gamma is acceleration or deceleration. If a driver is moving 60 miles and hour, and then puts the pedal to the metal the speed of the car will increase directly proportional to how much gas is applied to the car (obviously once a car moves faster other factors affect speed, but let’s not pick hairs). If the driver is moving 60 miles an hour and puts the brakes on, the car will reduce in rate of speed directly proportional to how hard the breaks are applied (along with the friction of road, but we will ignore that). If the car is moving in reverse instead of forward does that affect how quickly the car will accelerate of decelerate? The answer is no. Thus gamma and delta are INDEPENDENT of each other.
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