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Gamma hedging is a risk management strategy used by investors and traders to manage the risk associated with changes in the price of the underlying asset in options portfolios. It involves adjusting the portfolio's exposure to changes in the underlying asset's price by buying or selling the underlying asset or its derivatives.
Gamma is a measure of the rate of change of an option's delta with respect to changes in the price of the underlying asset. Delta represents the sensitivity of an option's price to changes in the price of the underlying asset. Gamma, on the other hand, measures how much the delta changes when the price of the underlying asset changes.
When an investor holds options in their portfolio, they are exposed to changes in the price of the underlying asset. If the price of the underlying asset changes, the delta of the options will also change, which can result in a change in the overall risk exposure of the portfolio. This change in risk exposure can lead to potential losses or gains.
Gamma hedging is important in managing options portfolios because it allows investors to adjust their risk exposure to changes in the underlying asset's price. By continuously monitoring and adjusting the portfolio's delta through gamma hedging, investors can maintain a more stable risk profile.
To implement gamma hedging, investors need to continuously adjust their positions in the underlying asset or its derivatives. If the delta of the options increases, indicating a higher sensitivity to changes in the underlying asset's price, investors can buy more of the underlying asset or its derivatives to increase their exposure. Conversely, if the delta decreases, indicating a lower sensitivity to changes in the underlying asset's price, investors can sell the underlying asset or its derivatives to reduce their exposure.
By actively managing the portfolio's delta through gamma hedging, investors can reduce the impact of price fluctuations in the underlying asset on their options positions. This helps to stabilize the portfolio's risk exposure and potentially minimize losses or maximize gains.
In summary, gamma hedging is a risk management strategy that involves adjusting the exposure to changes in the price of the underlying asset in options portfolios. By actively managing the portfolio's delta through buying or selling the underlying asset or its derivatives, investors can maintain a more stable risk profile and potentially minimize losses or maximize gains.