How Does the ‘Gamma’ of an Option Affect a Market maker’S Hedging Strategy and the Underlying Asset’s Liquidity?

The 'gamma' of an option measures the rate of change of its 'delta' in response to a change in the underlying asset's price. For a market maker, gamma is a critical risk metric.

A high gamma means that the market maker's delta exposure will change rapidly as the underlying asset's price moves, requiring frequent re-hedging. This re-hedging activity, which involves buying or selling the underlying asset, can increase the liquidity of the underlying asset, especially around key price levels.

However, it also exposes the market maker to 'gamma risk,' which is the risk of large losses if the underlying asset's price makes a large, sudden move.