What is a Gamma Squeeze?

In the investing world, squeeze indicates the number of times investors were forced to make a change in their investing position due to rapid price movement in the company’s stock. 

When the investors are forced to make changes, it results in price changes and forced moves. It further creates a nasty feedback loop, which can last for a while before it crashes. 

Traders are familiar with a common squeeze type, called a short squeeze. It’s a scenario where investors are forced to buy the stock they have previously sold. It happens due to the increased stock price. As a result, the stock rises. Now, gamma squeezes are related to a short squeeze. 

Stay tuned to know what is a gamma squeeze, where it comes from, and how it impacts investing. This post discusses gamma squeezes in detail. 

What Exactly is Gamma Squeeze and How it Impacts Market Makers?

As you know, squeeze in the investing world happens due to an unpredicted rise in stock price. In this scenario, gamma squeeze can take place when there is a widespread buying activity of short-dated call options for a certain trade. 

When this happens, an upward spiral is created, in which buying influences the higher stock prices. It results in even higher stock prices. 

As you can see, gamma squeezes are related to option trading. That means if you wish to understand gamma squeezes thoroughly, you must know about options trading. 

In options trading, everything is done through call and put options. A call option refers to buying shares of stocks at a given price at a given time. Now the thing is, someone on the transaction side must sell the shares of stock to the retail traders. 

This other party is known as the market maker, which works for a company, exchange, or bank. During the call buying process, market makers take on large short positions in the stock. If ever the price of stocks rises, they face a huge loss. 

In order to manage this thing, the market maker buys the stocks, which hedges their short options position. Ironically, this pushes the stock prices, which the market maker does not want. 

Thus, enters gamma squeeze. Now, to understand this term, you need to know about delta. Both delta and gamma squeezes are known as Greeks. Their main role is to help option traders understand the way option behaves relative to the underlying stock. 

Where Does Gamma Come from?

Delta shows how much the options price will move relative to a move in the underlying stock. It fluctuates from 0 to 1. Let’s assume a delta of 0.8 means for each US dollar the stock moves, and a change in the option premium will occur by 0.8. Gamma is the change in delta for each dollar the stock price moves. 

In short, delta shows how much market makers need to hedge. The below example will clear the true role of the delta. 

Imagine a situation where the market maker is short by selling 2000 call contracts at a strike price of $12. And the stock of this contract is currently trading at $8. As you can clearly see, the strike price is above stock. That means the market is good to go. 

In this situation, the delta can be somewhere between 0 to 0.1. Thus, the market does not have to hedge at all. 

However, with a rise in stock price, delta can approach 0.5 at the strike price. Here, they can measure this change. To deal with this situation, the market maker must buy more stock to adequately hedge. 

The delta now becomes the probability of an option expiring in the money. For example, a delta of 0.5 will have a 50% chance of expiring in the money. So, when the market is at the strike price, market makers have a half-half chance of whether the call will expire above the strike price or not. 

But if the price keeps increasing, the delta will also increase and reach 1. In this situation, the whole option must be hedged. 

When this happens on a larger picture, the market maker is forced to buy the price rise as a way to hedge the position. It is called gamma squeeze. 

In simple terms, gamma squeeze can be defined as a feature of the derivatives market when it becomes a part of options trading. Now, the price of these derivatives is determined by mathematical calculations, which then display gamma squeezes. And when the derivatives are close to the actual share price, gamma is at their highest. 

How does Gamma Squeeze Occur? 

In a general situation, gamma takes place in a short space of time by high trading volumes in one direction. As a result, the market maker exits their position, causing the share price to rise. 

Here, the trade is heavily influenced by world news and trader sentiments. What happens is that when the big financial news breaks, it results in larger than usual trade volume in a certain direction. 

Surely, the high market volume helps traders earn a good amount of money, but it’s not a good sign for market makers. High volume can force market makers out of their position. 

And when the market makers sell or buy their position, it puts pressure on the strike price. In this situation, the market maker tries to mitigate risk wherever possible. 

In short, gamma occurs when there is widespread speculation about the stock price’s direction. 

What Happens During Gamma Squeeze? 

As you know, gamma occurs when an increase in the stock market price forces investors to change their stock position. Usually, this squeeze takes place when there is a huge buying of short-dated call options of an individual stock, which causes a dramatic price surge. It further triggers the investors and makes them buy more calls, increasing the stock prices. 

One popular squeeze type is the short squeeze that forces the investors who shorted the stocks to buy those shares back. It increases the stock price even more. This squeeze occurs when short-sellers bet a decrease in the stock price. 

Similarly, when gamma squeeze takes place, it offers better trading opportunities to investors and traders. But this type of squeeze is risky. It is the main reason that timing is important on the gamma squeeze. When the gamma travels in the opposite direction, it could decrease the stock market price. 

How Does Gamma Squeeze Work? 

Making gamma occur is tricky because it requires several market conditions to meet. First, investors should bet that a particular stock’s price will increase. As a result, a huge purchase of short-dated call options occurs. 

As a result, institutional investors sell options in short positions. If this situation is prolonged and investors continue to purchase more stock options, institutional investors are forced to put more money in the shares. It is to ensure that they will have little to no net exposure. 

purchase call options, it results in more buying activity, which pushes the stock price up. And this is how gamma works. 

GameStop Gamma Squeeze Explained

A good example of it is the GameStop stock saga, which took place recently. What happened was that the stock price of this video game company increased by 400%. 

With this, the attention for this video game company increased, resulting in a spike in demand for GameStop call options. It further forces the option sellers to buy shares of the stock to reduce their risk. When options sellers purchased the shares, it drove them further price high. Thus, video game retailer rose. 

AMC Gamma Squeeze Explained

Similar to GameStop, there is another example of AMC entertainment. After the shirt squeeze of this company became uncontrollable, it became popular. The group then posted a positive trajectory. 

After that, a group of retail investors coordinated to drive up AMC entertainment holdings. As a result, the market maker was forced to take short positions. 

In simple terms, gamma affect stock prices greatly when a squeeze happens. This squeeze corrects itself most of the time, but it can cause short turbulence for traders even after that. 

Remember that whenever gamma squeeze takes place, there is always big news of a company that has made the market act erratically. Most of the time, this behavior leads to extreme short-term volatility that results in the squeeze. 

What Does Gamma Squeeze Mean for Investors? 

The good news is that when it happens, it could mean a good opportunity for investors. That said, the opportunity can turn out to be risky. 

How long the gamma stays totally depends on what’s inviting short squeeze and resulting gamma squeeze in the first place. So you see, the timing actually plays an important role in determining whether the gamma squeeze will result in loss or profit. 

Now, remember that price reversals occur after the gamma squeeze enters the peak. It results in a huge decline in stock prices. It is the main reason that options trading is not ideal for every investor until they have a good tolerance for risk. 

Gamma squeeze can surely offer great opportunities for investors. But it’s also important to remember the GameStop gamma situation where timing played a crucial role. 

Short Squeeze vs. Gamma Squeeze: What is the Difference? 

One might think that gamma squeeze and short squeeze are similar, but that’s not true. That’s because market makers cause gamma squeeze. 

Gamma squeeze is a situation that is caused when there are large trading volumes and unpredicted price movement. It makes the market makers leave the trades. A spike in the price traded by gamma can occur when this happens. 

On the other hand, a short squeeze is similar, but it happens with traders. Here also, the market moves strongly in a direction due to large volumes. This situation can force the traders to get out of their position. 

In case of a short squeeze, traders are forced to add additional funds or sell their trading accounts. The short squeeze has often resulted in unexpected increases in the stock value. 

How to Trade Gamma Squeeze?

Honestly, if you wish to trade gamma, you should have a high tolerance level. Also, it’s important to remember that no two gamma squeezes are similar as complexity arises in the situation. 

At certain times, you will notice sharp peaks and frequent price changes, and others will become weaker over time. 

If you want to gamma squeeze trading, you must understand timing. That’s because if, as a trader, you are not able to identify gamma squeeze and trade accordingly, you will lose a huge amount of money. Also, it’s necessary to have a fast and responsive trading platform. 

While trading gamma, you need to look at two factors: 

  • High Short-Stock Interest: If you want a squeeze to happen, you need traders who become stuck. That means you need a stubborn, short trader. 
  • Options Activity: Options are also important because there is less market movement when the traders play options. As a result, there remain few positions to squeeze. 

FAQ

How long does gamma squeeze last in stock prices? 

Depending on the factor driving the squeeze, it can stay for days or even weeks. But timing is extremely important in gamma as prices can rise even within a short period. 

What is the gamma of a stock price?

Gamma can be seen as a way to denote the rate of change in Delta for a unit price change in the index or underlying stock. In simple words, gamma measures movement risk. 

What is negative gamma?

If there is long gamma, you can conclude that in case of price fall, the Delta of a long put might move towards 1.00 and become more negative. Here, in case of a price rise, it will move towards 0 and become less negative. 

Is gamma scalping profitable?

Gamma scalping is the most profitable of all the gamma trading situations. The profitability increases when you purchase cheap implied volume. 

Conclusion

Gamma squeeze is basically a situation caused by high trading volume in a particular direction. As a result, these volumes can cause the market to close its positions, which increases the share price. 

If traders wish to trade gamma squeeze, they must identify events that can cause it. After identifying, they need to act quickly as timing is important. 

While trading gamma squeeze is profitable, it’s also risky. So, a trader must have a good risk tolerance before entering the gamma squeeze trading world. 

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