Dear all,
Schweser book4 LOS 30f pg 206 (Last para, second sentence)
Text says
‘Thus gamma of an at-the-money option is greatest near the expiration date.’
Can anyone add more context as to how to use this information in likely to appear on cfa exams.
If anyone could guide to other relevant threads will also be helpful.
Thank you
If they give you several options from which to choose for a delta hedge, it’s better to choose one that’s far out of the money or far in the money (where gamma is very low) than to choose one that’s at the money (where gamma is highest).
The main thing to understand here is that Gamma gets very high at expiration if the underlying price is near the strike. This is because one minute it looks VERY likely you will exercise your option (because the price might be above the strike on a call option), delta is near ONE in this case, and then the underlying might move just under the strike and suddenly your option looks VERY unlikely to not be exercised, delta is near zero in this case. So your delta flips very quickly from it’s minimum of ZERO to it’s maximum of ONE. Gamma (the derivative of delta wrt underlying effectively become infinite). So if you are trying to delta hedge using these option, you are in for a major headache. Use options that have a low gamma, so your delta doesn’t move around so much when the underlying changes.
Notice, by the way, that, despite the title of this thread, we’re not discussing _ gamma _ hedging (I’m not sure that there are any derivatives you could use for true gamma hedging, nor why you would bother doing it); what we’re discussing is the effect of gamma on delta hedging.