Zomma
What Is Zomma?
Zomma is a third-order risk measure of the degree to which the gamma of an options contract is sensitive to changes in implied volatility. It is likewise alluded to as "D-gamma/D-vol." Gamma itself is a second-order risk measure of a choice's sensitivity of its delta to changes in the underlying price.
Zomma is part of a category of measurements used to evaluate the price sensitivity of a derivative to different factors, for example, changes in interest rates, volatility, or the spot price of the derivative's underlying asset. These measurements are generally alluded to as "Greeks" since they are indicated by Greek images; be that as it may, "zomma" was made up by traders to seem like a Greek letter and isn't part of the Greek alphabet.
Grasping Zomma
Understanding zomma can be very challenging for the people who are not knowledgeable about the jargon of derivatives. This is on the grounds that zomma must be defined comparable to two other abstract concepts: gamma and delta. To comprehend the "real world" importance of zomma, you in this manner need to figure out gamma and delta also.
In view of that, we can start by expressing that zomma is a third-order derivative. This means zomma measures the change of a second-order derivative — explicitly, gamma. Gamma, thus, measures the sensitivity of delta to changes in the price of the underlying asset. In conclusion, delta measures the sensitivity of change between the underlying asset and the derivative product.
Derivative traders and portfolio managers frequently use zomma to decide the effectiveness of a gamma hedged portfolio. In this unique situation, zomma would measure variances in the volatility or potentially the underlying assets of that portfolio.
Gamma Hedging
Gamma hedging is a hedging strategy utilized corresponding to options or other derivative products. Fundamentally, the client of the delta hedging strategy means to safeguard against the risk that the price of the derivative will become decoupled from the price of its underlying asset. Zomma is an important measurement in this unique situation.
Real World Example of Zomma
Derivative portfolios can have extremely dynamic risk profiles. For example, their risk can shift in light of factors, for example, price variances in the underlying assets, changes in interest rates, or acclimations to implied volatility.
To keep track of this consistently advancing risk profile, derivative traders utilize different measurements. For instance, delta is a measurement of how much profit or loss will be generated as the prices of the underlying assets go up or down. Notwithstanding, even this apparently clear concept is more nuanced than it shows up. This is on the grounds that the relationship among delta and the underlying asset's price developments isn't linear. This gives rise to a subsequent measure, gamma, which tracks the sensitivity of delta to those price changes. In this sense, delta is a first-order measurement, while gamma is a second-order measurement.
Zomma, in conclusion, measures the rate of change of gamma comparable to changes in implied volatility. For instance, in the event that zomma = 1.00 for an options position, a 1% increase in volatility will likewise increase the gamma by 1 unit, which will, thus, increase the delta by the amount given by the new gamma. If the zomma is high in absolute terms (either positive or negative), it will demonstrate that small changes in volatility could deliver large changes in directional risk as the underlying price moves.
Highlights
- Zomma is a choice's sensitivity of gamma to changes in implied volatility, where a higher zomma demonstrates small changes in IV convert into large changes in gamma.
- It is one of the alleged minor Greeks used to oversee higher-order risk in derivative trading, most usually with regards to options trading.
- Zomma is a highly abstract concept that must be perceived comparable to different measurements used to assess a choice's risk position.
