Question

Gamma hedging is needed when hedging in the Black-Scholes-Merton model because:

Group of answer choices

there is interest rate risk in holding the option

there is volatility risk in holding the option

when hedging, one can only trade discretely in time and not continuously

there is time decay in holding the option

please provide explanation

Answer 1

when hedging, one can only trade discretely in time and not continuously

Gamma is derivative of delta with respect to interest rate.

Gamma hedging is added to a delta-hedged strategy to try and protect a trader from larger than expected changes to a security, or even an entire portfolio, but most often to protect from the effects of rapid price change in the option when time value has almost completely eroded.

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