Question

Explain why immunizing a portfolio and making it Gamma neutral only may be ineffective in removing underlying price risk.

Answer 1

A portfolio is a combonation of different securities. The purpose of creating such a portfolio is to derive the maximum while reducing the risk.

A gamma neutral is a way of reducing and managining  the risk in option portfolio. It is being immunized so that it can be protect against large move of the underlying securities. he directional risk of the option can be changed by using delta hedging. A gamma neutral can be made by incorporating the offsetting gamma values.

A gamma neutral portfolio helps in protecting the variations due to changes in market condition and the prices of the security. But, it is not only sufficient to make gamma neutral portfolio. It is made on certain assumptions and if they turn the other way then it can affect. For example, if the assumotions of the portfolio turns out to be incorrect then risk will rise. The options market is very dynamic in nature so it changes as the time passes. So, making the portfolio gamma neutral is not sufficient and other measures needs to be taken in order to shield from the risk.