Gamma Hedging: Why Dealers Adjust Their Coverage All Day Long

Before this article: Gamma Explained: The Rate of Change of Delta.

Hedging isn't a one-time event

In the Delta Hedging article you saw the formula for how much a dealer needs to hedge at a given moment: $Q = \Delta \times N \times M$. The problem is Delta doesn't sit still: it changes with every point the price moves, because that's exactly what Gamma measures.

That means the dealer doesn't calculate their hedge once when they sell the option. They recalculate it constantly, all day long, every time the price moves enough. That continuous rebalancing practice is called Gamma Hedging.

The incremental adjustment formula

How much the dealer needs to ADDITIONALLY buy or sell when the price moves by $\Delta S$:

$$ \Delta Q = \Gamma \times \Delta S \times N \times M $$

Where:

$\Delta Q$ = additional quantity of the underlying to buy/sell from the price move.
$\Gamma$ = the option's Gamma.
$\Delta S$ = how much the underlying's price moved.
$N$ = number of contracts.
$M$ = the contract multiplier.

Key idea: this formula is the real reason Gamma is the piece that actually moves the market. Delta tells you the initial hedge. Gamma tells you how much that hedge gets rebalanced every time price advances.

High Gamma vs low Gamma: rebalancing frequency

	High Gamma (e.g. ATM, near expiration)	Low Gamma (e.g. far from price, many days to expiration)
Rebalancing frequency	Very high: the dealer rebalances on every small move	Low: the dealer barely needs to touch their hedge
Market effect	Each rebalance adds real buy/sell pressure	Marginal, almost unnoticeable
Where it typically happens	Strikes near the current price, 0DTE options	Far strikes, options with weeks/months to expiration

flowchart TB
    A[Price moves ΔS] --> B{High Gamma<br/>at that strike?}
    B -->|Yes| C[Large, frequent rebalancing]
    B -->|No| D[Small, infrequent rebalancing]
    C --> E[Real, sustained<br/>pressure on price]
    D --> F[Marginal effect]

Numeric example

Picking up the previous article's example: dealers holding 10,000 calls on the underlying, 0.40 Delta, 0.02 Gamma, 100 multiplier.

Example: if price moves an additional 10 points:

$$\Delta Q = 0.02 \times 10 \times 10{,}000 \times 100 = 200{,}000 \text{ additional index units to hedge}$$

That's on top of the 400,000-unit initial hedge you saw in the Delta Hedging article. Illustrative figures to show the mechanics.

Next step

So far you've seen one dealer's behavior. The next article scales this same mechanic up to the whole market: thousands of positions aggregating into a single number that describes dealers' total exposure: Gamma Exposure.

Continue with: Gamma Exposure: How Dealer Gamma Moves the Market Price