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Gamma measures the risk that remains once the portfolio is delta neutral (non-linearity risk).

The BSM model assumes that share prices change continuously with time. In reality, stock prices do not move continuously. Instead, they often jump, and this creates **gamma risk.**** **

Gamma risk is so-called because gamma measures the risk of share prices jumping when hedging an options position, leaving an otherwise hedged option position abruptly unhedged.

A delta-hedged portfolio is said to have a negative net gamma exposure if it has short position in calls and a long position in stocks.

## Question

Which of the following statements is

most accurate:

- Gamma measures linearity risk
- Gamma risk is created when stock prices move continuously
- Gamma risk results from share prices jumping when hedging an options position, leaving the hedged position suddenly unhedged
## Solution

The correct answer is C:Gamma risk is so-called because gamma measures the risk of share prices jumping when hedging an options position, leaving an otherwise hedged option position abruptly unhedged.

A is incorrect:Gamma measures non-linearity risk, i.e., the risk that remains once the portfolio is delta neutral.

B is incorrect:The BSM model assumes that share prices change continuously with time. In reality, stock pricesdo notmove continuously. Instead, they often jump, and this createsgamma risk.

*Reading 38: Valuation of Contingent Claims*

*LOS 38 (m) Describe the role of gamma risk in options trading; *