You’re probably here because you:
- Heard about this “Gamma Squeeze” phenomenon
- But you’re not sure what it means
- So you want to understand
Join us, and let’s explore what a gamma squeeze really is. Let’s go!
What is a Gamma Squeeze?
A gamma squeeze is a situation in the stock market where a rush in buying of call options on a particular stock forces market makers to buy more of the underlying stock to hedge their positions.
This can cause the stock price to rise sharply, creating a self-reinforcing cycle of buying and further price increases.
In simpler terms: A gamma squeeze is like a snowball rolling downhill.
It starts small but gets bigger and bigger as it gains momentum.
An easier way to get it
Imagine a game of musical chairs where there are more people than chairs. As the music starts, people rush to grab chairs, and those who don’t find a seat are out. In the stock market, call options are like promises to buy a chair if the music stops.
- When people buy lots of call options on a particular stock, it’s like adding more people to the game.
- This can create a rush to buy the actual stock, causing the price to rise sharply.
- People who run the game are supposed to make sure there are enough chairs for everyone.
- But when the price of the stock rises, they need to buy more chairs to fulfill their promises.
This buying pressure can further drive up the stock price, creating a self-reinforcing cycle of buying and price increases.
Gamma squeeze vs Short squeeze
|Increased buying of call options
|Increased selling of borrowed stock
|Who is affected
|Market makers buy underlying stock to hedge their call option positions
|Short sellers are forced to buy the stock back to close their positions
|Sharply rising stock price
|Sharply rising stock price
|Can be more prolonged
|Market makers can incur losses if the stock price falls
|Short sellers can incur losses if the stock price rises
Gamma squeeze: Triggered by a surge in buying of call options, which are contracts that give the buyer the right to buy a stock at a certain price by a certain time. As call option prices rise, market makers, who sell these contracts, are forced to buy more underlying stock to hedge their positions. This buying pressure can drive up the stock price further, creating a self-reinforcing cycle.
Short squeeze: Triggered by increased selling of borrowed stock. Short sellers sell shares that they don’t own, hoping to buy them back later at a lower price.
When the stock price rises, short sellers are forced to buy back the stock to close their positions, which can further drive up the price.
Causes of a gamma squeeze
Gamma squeezes can happen due to widespread speculation regarding the future direction of a stock’s price. For instance, if a company is facing financial difficulties:
- It’s common for institutional investors to short sell the stock…
- Anticipating a decrease in its price.
However, what’s not typical is: When a large group of investors or a singular major institutional investor begins to aggressively purchase shares, leading to a short squeeze.
- Retail trader enthusiasm: When retail traders buy large numbers of call options, it can trigger a gamma squeeze. This is because retail traders often lack the sophisticated risk management practices of institutional investors, which can make them more susceptible to herd mentality and FOMO (fear of missing out).
- Positive news: News that is considered positive for a stock can also trigger a gamma squeeze. This is because positive news can cause investors to buy call options, which can then trigger a gamma squeeze.
- Technical analysis: Some traders believe that they can identify stocks that are vulnerable to gamma squeezes based on technical analysis. This includes looking for stocks that have a high gamma and a recent uptrend.
Examples of squeezes
- The GameStop short squeeze in January 2021: This was the most famous example of a gamma squeeze in recent history. The stock of GameStop, a video game retailer, rose from $40 per share to over $480 per share in just a few weeks.
- The AMC short squeeze in June 2021: This was another high-profile gamma squeeze. The stock of AMC Entertainment, a movie theater chain, rose from $14 per share to over $60 per share in just a few weeks.
Gamma squeezes are a complex phenomenon that can be difficult to predict. However, they are a reminder of the power of market forces and the potential for rapid price swings in the stock market.
Risk and meaning of a squeeze
Gamma squeezes can have a significant impact on stock prices (not options!).
- In some cases, they can even cause stocks to double or triple in value in a very short period of time.
- This can be a boon for investors who have bought call options, but it can also be a disaster for investors who have shorted the stock.
Also, let’s not forget that gamma squeezes are risky for market makers as well. So… Nobody is really safe!
What happens in a gamma squeeze
- Market makers are forced to buy large amounts of stock.
- This can put them at risk of losses if the stock price falls.
- Hence, they can lead to margin calls.
This can force market makers to liquidate their positions, which can further develop the gamma squeeze.
A gamma squeeze is a self-reinforcing cycle in the stock market, triggered by a surge in buying call options. As call option prices rise, market makers, responsible for fulfilling these options, must buy more underlying stock, exacerbating the price rise. This can lead to rapid and dramatic stock price movements.
Frequently Asked Questions
What triggers a gamma squeeze?
Gamma squeezes can be triggered by a surge in buying call options, widespread speculation, retail trader enthusiasm, positive news, or technical analysis. They can also be triggered when there’s significant short interest in a stock
What is the difference between a gamma squeeze and a short squeeze?
While both gamma squeezes and short squeezes can lead to rapidly rising stock prices, they are initiated differently and affect different parties. A gamma squeeze is initiated by increased buying of call options and primarily affects market makers. A short squeeze is triggered by increased selling of borrowed stock and primarily affects short sellers.
What are the risks associated with a gamma squeeze?
Gamma squeezes can be risky for market makers who are forced to buy large amounts of stock, putting them at risk of losses if the stock price falls. They can also be risky for investors who have shorted the stock.
How long does a gamma squeeze last?
The duration of a gamma squeeze can vary, but they are typically short-lived