If you are looking for an investment opportunity, the stock market may seem to be a viable solution. However, there is always a risk involved while trading on the stock exchange. The volatility and the uncertainty have sunk many growing investors into debts. This is why gamma exposure is an important factor to consider before investing or divesting the stocks. Predicting the nature of the stock and its performance has always been luring investors. GEX does the same by measuring the gamma level of the market. This is also known as gamma hedging that also goes with delta hedging that we will discuss in the next section. But for time being, the technical definition of gamma exposure is the second-order derivative of price sensitivity over underlying security.
Gamma and Delta hedging
The best way to understand these hedging techniques is through an example. So, follow the following instance carefully to understand how gex can help you in purchasing or selling the stocks. But before we begin, we must inform you that there are two gamma types – long gamma and short gamma. For the sake of simplicity, we will use the example for long gamma.
So, you bought some shares whose delta value is 0.5. Now, you can long your position by selling 50 shares of the security. Thus, the gamma becomes 0. Now, if the selling price of the security increased by a 1-point factor, the delta becomes 0.6 and the gamma becomes 0.1. Similarly, a 2-point increase in selling price will increase the gamma by 0.2 making the delta hedge 0.8. So, you are selling the share for each point increase in the security price. This eventually means that you sell shares for each point increase. On the other hand, the short gamma has the reverse effect on trading. In short gamma, you will buy shares for each point decrease in the security price.