Gamma Explosion: Expiry day trade with exploding returns
Look for a stock that has capacity to move from current price to the next higher Call strike or Next lower Put strike.
F&O Market
Gamma Explosion or Gamma Bust is one of the mightiest explosions in the universe. We are talking about something similar but referencing Options. In the world of Options Gamma means the pace of Change in Premium for every Rupee move in the stock of index.
The Gamma Explosion up for discussion here is The Factor that is responsible for the Options behaving like lottery tickets. Re 1 options turning into Rs 100 in matter of minutes on the day of expiry is a result of Gamma Explosion.
Let us say for Re 1 rise in stock a Call Option the premium rose by 50p for next Re 1 the same Call Option rose by 55p for next 62p. This rise from 50p to 55p to 62p is understood by Gamma of the Option. So, it is the pace of rise in Options.
Now this sensitivity of pace of rise in Option is not usually the same across the entire life of the Options. Let us know a particular feature that makes Gamma special and separates from the others.
What is Gamma’s time feature?
As we all know time is not a friend of Option premium. Passage of time has negative impact on Option premium. As time passes Option premiums go down. That is true for most of the other factors too. As time passes the impact of one of the other factors like Expected Volatility also reduces.
However, the Gamma effect becomes more visible as we come closer to Expiry. This is more visible in Higher Strikes Calls and Lower Strike Puts. When the stock or index rise, the Higher Calls would rise at a higher pace when we are closer to Expiry.
How Does this Work?
Let us Understand with a practical example. Same stock with same level of expected volatility no results or other events in sight goes thru the same size of move and let us see how Call Options behave at different points in expiry.
One notable in the above example is the strike price of the Call Options at 1020 which is higher than the stock price in both the cases. Same would be the case if we were to look at Lower strike Put Options.
How to Use Gamma Explosion?
All we need to do is with whatever best analytic at disposal, look for a stock that has capacity to move from current price to the next higher Call strike or Next lower Put strike.
Once ready just jump into to the trade with a stop-loss. If everything goes to plan one may be able to see premiums as high as 2-3 times of that of entry premiums. Stop loss can be followed in the underlying. Ideally these are intraday trades and I recommend closing the trade before the market closes.
Thus, just by choosing the right Option at the right time with the help of Gamma Explosion one can easily convert a small move in stock or index into a big return on Option Premium.
First published on 9 Sep 2023: prices, lot sizes and expiries are those of that time. They are illustrations for education only, not investment advice. Derivatives trading carries risk; read all scheme and risk documents before trading.
