Now that we have covered delta in our previous post: Thinkorswim: Terminology – Delta, it is time to take a look at how much delta moves when the price of a stock changes. This measure is called Gamma.
Options Trading: Gamma
Gamma is the estimate of how much the delta of an option changes when the price of the underlying stock moves $1.00. Gamma essentially tells you how stable your delta is. A big gamma indicates that your delta can change dramatically even if the underlying stock only moves slightly. Long calls and puts always have positive gamma, while short calls and puts always have negative gamma. Positive gamma means that the delta of long calls will become more positive as the underlying stock price rises, and move towards 0.00 as the underlying stock price falls.
Using the same example from Thinkorswim: Terminology – Delta, the SPX Sept10 1090 call has a delta of +0.5408 and a gamma of 0.69. If the SPX moves up $1.00 to $1,095.16, the delta of the call would become 0.91 (+.5408 + ($1 * 0.69)). However, gamma is always highest when the call is at the money. So, you delta jumps closer to one, but gamma would drop as the call moves into-the-money. In practice, the delta of 0.91 makes sense, but in reality, it would rise, but not that high. Other factors, such as volatility, play a role as well.
Basically, what a trader wants to look for is a position with positive gamma because a position with positive gamma is relatively safe as it will generate deltas as the stock moves. A position with negative gamma will generate deltas that will hurt your position. Gamma is a good reason to look at the Analysis page in Thinkorswim.