{"id":15143,"date":"2021-05-10T11:54:01","date_gmt":"2021-05-10T11:54:01","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=15143"},"modified":"2025-12-23T14:40:50","modified_gmt":"2025-12-23T14:40:50","slug":"role-of-gamma-risk-in-options-trading","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/role-of-gamma-risk-in-options-trading\/","title":{"rendered":"Role of Gamma Risk in Options Trading"},"content":{"rendered":"\r\n<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"Which of the following statements is most accurate?\",\r\n    \"text\": \"Which of the following statements is most accurate?\\n\\nA. Gamma measures linearity risk.\\nB. Gamma risk is created when stock prices move continuously.\\nC. Gamma risk results from share prices jumping when hedging an options position, leaving the hedged position suddenly unhedged.\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"Gamma risk results from share prices jumping when hedging an options position, leaving the hedged position suddenly unhedged.\\n\\nGamma risk arises because gamma measures the sensitivity of delta to changes in the underlying asset\u2019s price. When prices jump rather than move continuously, a delta-hedged position can quickly become unhedged.\\n\\nGamma measures non-linearity risk, not linearity risk, and continuous price movements are assumed in models such as Black\u2013Scholes\u2013Merton; in practice, price jumps are what create gamma risk.\",\r\n      \"dateCreated\": \"2025-12-23\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n\r\n<p>Gamma measures the risk that remains once the portfolio is delta neutral (non-linearity risk).<\/p>\r\n<p>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 <strong>gamma risk.<\/strong><strong>\u00a0<\/strong><\/p>\r\n<p>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.<\/p>\r\n<p>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.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Which of the following statements is <em>most accurate<\/em>:<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n<li>Gamma measures linearity risk<\/li>\r\n<li>Gamma risk is created when stock prices move continuously<\/li>\r\n<li>Gamma risk results from share prices jumping when hedging an options position, leaving the hedged position suddenly unhedged<\/li>\r\n<\/ol>\r\n<h3>Solution<\/h3>\r\n<p><strong>The correct answer is C:<\/strong><\/p>\r\n<p>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.<\/p>\r\n<p><strong>A is incorrect: <\/strong>Gamma measures non-linearity risk, i.e., the risk that remains once the portfolio is delta neutral.<\/p>\r\n<p><strong>B is incorrect: <\/strong>The BSM model assumes that share prices change continuously with time. In reality, stock prices <strong>do not<\/strong> move continuously. Instead, they often jump, and this creates <strong>gamma risk.<\/strong><\/p>\r\n<\/blockquote>\r\n<p><em>Reading 38: Valuation of Contingent Claims<\/em><\/p>\r\n<p><em>LOS 38 (m) Describe the role of gamma risk in options trading; <\/em><\/p>\r\n","protected":false},"excerpt":{"rendered":"<p>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&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,302],"tags":[216,304,336,339],"class_list":["post-15143","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-derivatives","tag-cfa-level-2","tag-derivatives","tag-reading-38","tag-role-of-gamma-risk-in-options-trading","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Role of Gamma Risk in Options Trading - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"Gamma measures the risk that remains once the portfolio is delta neutral (non-linearity risk).\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/role-of-gamma-risk-in-options-trading\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Role of Gamma Risk in Options Trading - 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