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

Question

Quizplus · Accepted Answer

Gamma hedging is required in the Black-Scholes-Merton model because the assumption of continuous trading is impractical. In reality, trading occurs discretely in time, which results in the option's delta being constantly changing. Gamma hedging involves continuously adjusting the hedge ratio to account for changes in the option's delta, thus reducing the risk of the hedging strategy. Volatility risk (A), interest rate risk (B and D), and time decay (E) are all factors that impact the option's price, but they are not necessarily the primary drivers of the need for gamma hedging in the model.

Gamma Hedging Is Needed When Hedging in the Black-Scholes-Merton Model