Gamma Neutral: What It Means and How It Works

Key takeaways
* A gamma neutral portfolio is structured so its delta does not change materially when the underlying security moves—i.e., the rate of change of delta (gamma) is offset.
* Gamma neutrality is achieved by combining positions with offsetting gamma exposures, typically by adding options (gamma hedging).
* Gamma hedging reduces directional risk from large moves but requires ongoing rebalancing and creates trade-offs with time decay (theta) and volatility sensitivity (vega).

What is gamma?
* Gamma is one of the “Greeks” used to measure option risk. It quantifies how much an option’s delta changes for a small change in the underlying asset’s price.
* Delta measures the sensitivity of an option’s price to changes in the underlying; gamma measures the sensitivity of delta itself.
* High gamma means delta moves quickly as the underlying moves; low gamma means delta is more stable.

What does gamma neutral mean?
* A gamma neutral position has a net gamma close to zero, so the portfolio’s delta remains approximately stable when the underlying price moves.
* Practically, traders achieve gamma neutrality by adding options (or other instruments) whose gamma offsets the gamma of the existing position. This process is called gamma hedging.
* A gamma neutral position can still have a nonzero delta (i.e., be directionally long or short) if the trader wants to maintain exposure while stabilizing delta changes.

How gamma hedging works
* Identify the portfolio’s net gamma exposure.
* Add or subtract option positions to offset that exposure (for example, buying or selling calls/puts with specific strikes and maturities).
* Rebalance regularly: gamma depends on the underlying price and time to expiration, so hedges must be adjusted as market conditions and time decay change.

Uses and practical benefits
* Reduce directional risk: gamma hedging prevents a delta-neutral position from becoming a directional bet when the underlying moves.
* Lock in gains: after a profitable move, a trader can hedge gamma to protect profits while retaining potential upside from continued favorable moves.
* Manage volatility exposure: traders can design positions that are stable across a range of underlying prices, useful in volatile markets.

Trade-offs and risks
* Rebalancing costs: keeping gamma near zero requires frequent adjustments, which incur transaction costs and slippage.
* Theta and vega impacts: options used to hedge gamma introduce or change exposure to time decay (theta) and implied volatility (vega). For example, long gamma is often short theta.
* Model and execution risk: hedges depend on pricing models and assumptions; if those are wrong or markets gap, the hedge can fail.
* Not permanent: gamma neutrality is dynamic—changes in the underlying, volatility, and time to expiration mean continuous monitoring is necessary.

Gamma neutral vs. delta neutral
* Delta neutral means the portfolio’s immediate directional sensitivity is zero, but delta itself can change if gamma is nonzero.
* Gamma neutral means delta will not change much as the underlying moves (i.e., delta’s rate of change is neutralized). A position can be both delta neutral and gamma neutral (often achieved via delta-gamma hedging), or gamma neutral while maintaining a targeted delta exposure.
* Example concept: a trader who is long calls and short shares might be delta neutral by selling some shares. If they worry delta will shift as the stock moves, they add another option (e.g., a short call at a different strike) to offset gamma—this is adding a gamma hedge.

Summary
Gamma neutrality is a dynamic risk-management technique in options trading that stabilizes the portfolio’s delta by offsetting gamma. It reduces susceptibility to large underlying moves but requires active management and introduces trade-offs with costs, time decay, and volatility exposure.