Gamma Neutral Options Strategies

Gamma Neutral Trading Explained

Gamma neutral options strategies can be used to create new positions or to adjust an existing one. The goal is to use a combination of options that will make the overall gamma value as close to zero as possible. A zero value will mean that the delta value shouldn't move when the price of the underlying security moves. There are a few reasons why you would want to do this, which we look at a little later.

Technically you can use any combination of options you want to create a gamma neutral position. As such these strategies are a little different from most others, where there are specific transactions that you need to make in order to create a spread that is in line with your objectives. This is largely why we only recommend that experienced traders use these strategies; you need to be able to work out exactly what you are trying to do and why.

Managing Volatility of a Position

The gamma value of an options position essentially represents the volatility of that position. It therefore makes sense that creating a gamma neutral position is useful if you wish to be exposed to as little volatility as possible.

By creating a position that is gamma neutral, but delta positive, you can benefit from predictable profits (assuming the underlying security moves as you expect) without being exposed to exponential losses if things don't turn out as you predicted. This is useful if you wish to hold a long term position on a security that you expect to increase in value over time, but wish to reduce the effect of any unexpected moves.

Trading Implied Volatility

It's possible to create an options position that isn't affected by any moves in the price of an underlying security, but that will benefit from changes in the implied volatility. To do this you have to make sure a position is both gamma neutral and delta neutral. Doing so will effectively make you long on vega, meaning you will profit when implied volatility rises.

This is a useful strategy if you identify an opportunity where the implied volatility is likely to change, but you aren't sure in which direction the price of the security will move, or whether it will move at all.

If you aren't familiar with implied volatility, please click here for further information.

Protecting Profits

When trading options it's quite likely you will encounter a scenario where an existing position has made you a decent profit and you want to protect some or all of that profit. The obvious way to do this is to close the position and take your money, but you won't be able to make any further profits if you do this. By using a gamma neutral strategy, you can potentially have the best of both worlds in such a situation.

If you adjust your position in a way that makes it delta neutral and gamma neutral, you will automatically make it theta neutral too. This means that your position won't be affected by further price moves in the underlying security or by time decay. It can still benefit from rising volatility though.

This is a viable approach if you have made profits on a security that could possibly move in price significantly soon (for example there's earnings announcement due), but you aren't sure in which direction the price will move. By making your position delta neutral and gamma neutral you can protect the profits you have already made and make further profits as the volatility increases. Once you expect the period of volatility to end, you can then adjust your position again (or close it completely) based on your expectations at that point.