What is Gamma Neutral
Achieving a gamma neutral position is a method of managing risk in options trading by establishing an asset portfolio whose delta rate of change is zero. A gamma-neutral portfolio hedges against second-order time price sensitivity. Gamma is one of the "options Greeks" along with delta, rho, theta, and vega. These are used to assess different types of risk in options portfolios. The risk level of an options portfolio could also be managed through delta neutral, theta neutral and vega neutral strategies, which are used to hedge against the risks of price sensitivity, time sensitivity, and implied volatility.
BREAKING DOWN Gamma Neutral
A gamma neutral portfolio can be created by taking positions with offsetting deltas. This helps to reduce variations due to changing market prices and conditions. A gamma neutral portfolio is still subject to risk, however. For example, if the assumptions used to establish the portfolio turns out to be incorrect, a position that is supposed to be neutral may turn out to be risky. Furthermore, the position has to be rebalanced as prices change and time passes.
The gamma value of an options position essentially represents the volatility of that position. It, therefore, makes sense to create a gamma neutral position if you wish to be exposed to as little volatility as possible. Gamma neutral options strategies can be used to create new security positions or to adjust an existing one. The goal is to use a combination of options leaving the overall gamma value as close to zero as possible. At a value near zero, the delta value shouldn't move when the price of the underlying security moves.
Sealing in profits is a popular use for gamma neutral positions. If a period of high volatility is be expected and an options trading position has made a good profit to date, instead of locking in the profits by selling the position, thus reaping no further rewards, a delta neutral gamma neutral hedge can effectively seal in the profits.