In a very technical sense, a long gamma means that the delta of the trader's position will increase by a certain amount described by gamma for each $1 move in the underlying stock. Now, let’s cut through that jargon and simplify a bit (without oversimplifying).
Delta is a commonly accepted way in which we look at price movement of an option relative to the stock price. A delta (change) in price is set as a 1:1 relationship; a delta of 1 means that the price of the option changes at 100% in line with the changes to the stock price. If the stock price rises $1, the theoretical price of the option will also rise $1.
For example, an option with a delta of negative 0.5 (-50%) would fall by 50 cents, relative to a $1 increase in the stock price. When you are long gamma, you benefit from the appreciation of the underlying asset such that the options contracts, which were purchased (likely) at a fraction of the underlying stock value, start to behave more and more stock-like.
Seems pretty straight forward, right?
Then what is meant by gamma, particularly as it related to a single option contract or multiple options in the form of a spread? An option has a delta of +0.5 relative to the price of its underlying stock or half (it will increase by $0.50 for every $1 increase in the underlying stock). However, with this price move, the delta of the position would also change. The delta would increase if the option(s) had to move either closer to or further in-the-money and would decrease in the opposite direction.
Gamma describes how much the delta is expected to change with a given price move. If you are long the options, then you would prefer having a higher gamma and if you are short the position you would be looking for a low gamma.
So what does this all mean in practice? I am the co-founder of a startup called, OptionAutomator, where we use multi-criteria decision-making technology for balancing conflicting criteria in automated trade discovery tool, The Brutus Options Ranker. From my experience, Gamma is one of the most important criteria that is added to our user’s strategies.
If the trader is net-short options in their position, they will almost always look to minimize gamma. The contrary is also true, if the trader is net-long options then they will almost always look to maximize gamma. Of course, this never comes free.
Taking the example of the net-short trader, they may look to minimize gamma but also maximize theta (the amount the position decays in value with no underlying market movements) this creates a tradeoff that must be considered and managed.
