What is gamma in financial terms?

Gamma is defined as the measure of sensitivity of delta to changes in the value of the underlying asset. In options trading, delta represents the rate of change of an option's price with respect to changes in the price of the underlying asset. Gamma, therefore, provides insight into how much the delta itself would change when the underlying asset's price moves. A high gamma indicates that delta can change dramatically with small movements in the underlying asset, which is important for traders managing the risk of their positions, particularly in volatile markets.

Understanding gamma is crucial for options traders as it helps them assess the second-order risk associated with their options strategies. When gamma is positive, an increase in the underlying asset's price will increase the delta, enhancing the potential for profit as the option becomes more sensitive to further price movements. Conversely, a decrease in the underlying asset's price can sharply reduce the delta, leading to more precise risk management decisions.

In contrast, the other responses do not accurately depict the concept of gamma. The risk-free rate of return refers to the theoretical return on investment with no risk of financial loss, while a method of calculating portfolio risk typically involves metrics like beta or standard deviation. The rate at which an asset's price changes pertains more to volatility or momentum than