We use cookies to understand how you use our site and to improve your experience. This includes personalizing content and advertising. To learn more, click here. By continuing to use our site, you accept our use of cookies, revised Privacy Policy and Terms of Service.
You are being directed to ZacksTrade, a division of LBMZ Securities and licensed broker-dealer. ZacksTrade and Zacks.com are separate companies. The web link between the two companies is not a solicitation or offer to invest in a particular security or type of security. ZacksTrade does not endorse or adopt any particular investment strategy, any analyst opinion/rating/report or any approach to evaluating individual securities.
If you wish to go to ZacksTrade, click OK. If you do not, click Cancel.
What is a Gamma Squeeze? Understand the GameStop Play
Read MoreHide Full Article
“Gamma squeeze” is a relatively obscure term understood by experienced options traders. However, as of late, gamma squeezes are occurring more often than ever on Wall Street, so investors should educate themselves on the term.
What is a Gamma Squeeze?
In options markets, a gamma squeeze occurs when a stock swiftly rallies due to market maker hedging.
Options 101
To clearly understand gamma squeezes, investors must first have a handle on the inner workings of the options market. Options are financial derivatives that provide the owner the right, but not the obligation, to buy (call options) or sell (put options) of an underlying asset at a specified price before the expiration date.
Options Greeks
Though options are roughly correlated to the underlying asset’s price movements, options pricing is a bit more complex than equity pricing, for example. Option Greeks are a group of gauges that allow traders to understand how an option price is expected to change. However, it is critical for investors to understand that equities can impact options pricing and vice versa.
Delta
Delta measures how much an option price will change with every $1 move in the stock. Envision delta as the speedometer on your car. If your speedometer displays 40 miles per hour, that would be akin to your delta.
Gamma
Gamma is a metric that gauges the rate of change in the delta relative to every $1 move in the stock. For example, 100 shares of stock would have a 0 gamma and a 100 delta. Using the same example from earlier, if you speed up from 40 to 50 MPH, your gamma is 10. Gamma represents the change in delta.
Anatomy of a Gamma Squeeze: The GameStop Example
To explain a gamma squeeze, I will use the most famous example, GameStop ((GME - Free Report) ). I will also use metaphors to make the concept easy to understand. A gamma squeeze has four ingredients:
1. A Flurry of Call Buying: Traders buy a plethora of out-of-the-money call options. In the case of GameStop, the call buying was largely attributed to speculative retail investors who were members of the Reddit ((RDDT - Free Report) ) “subreddit” community called “r/WallStreetBets.” Community members coalesced to take advantage of the high short squeeze in GME and orchestrate a short squeeze.
2. Hedging Market Makers: Market makers are mostly Wall Street firms that provide liquidity to various markets, including the options market. In the options market, these entities provide liquidity by allowing traders to buy and sell options. They continuously quote buy and sell prices for options, better known as the bid-ask spread. Market makers implement historical stats and probability to profit from the difference between the bid and ask.
Fuel added to the Fire: When a market maker sells call options, they need to hedge by purchasing underlying shares because if the stock rises, they must deliver stock to option buyers. In other words, the more call options market makers sell, the more stock they need to buy. In the case of GME, the number of shares market makers needed to purchase was dramatically increased due to the increased popularity of 0DTE (zero days until expiration) options and far out-of-the-money calls.
3. Price Momentum and Feedback Loop: The shares purchased by market makers drive the stock higher. A rising stock price leads to a higher delta, forcing market makers to buy even more stock to manage risk through hedging. The chain of events sparks a feedback loop that includes:
A. Heavy Call Buying
B. Rapidly Increasing Delta
C. Stock Purchases by Market Makers to Hedge Positions and Manage Risk
Beyond the feedback loop mentioned, GameStop’s gamma squeeze in late 2020 was particularly extreme. Short sellers were forced to cover as the stock rose, and retail investors jumped on board to take speculative bets. Remember, at the time, many people were confined to their homes and flush with cash thanks to stimulus checks handed out during the COVID-19 pandemic. Furthermore, discount broker Robinhood ((HOOD - Free Report) ) had just become the first stock broker to employ zero-commission equities trading.
Image Source: Zacks Investment Research
Gamma Squeezes: A Word of Caution
Investors who decide to trade a gamma squeeze should be extremely careful. In fact, for most investors, spectating is the best course of action because:
Hyper Volatility: Gamma squeezes result in massive price ranges and overnight gaps.
Traders are not in Control: GME and other gamma squeezes like AMC ((AMC - Free Report) ) add risk to the equation that is impossible for traders to account for. For instance, Keith Gill, known in online trading circles as “Roaring Kitty,” rose to fame on the r/WallStreetBets subreddit. Social media posts by Gill can often move a stock like GME by 20% or more. Furthermore, stock exchanges and regulators can halt stock for various reasons
Gamma Squeezes are Not Sustainable: Gamma squeezes are unsustainable because they are a phenomenon that is detached from fundamentals. Like a game of musical chairs, latecomers bear the brunt of the pain when the stock crashes downward.
Bottom Line
A gamma squeeze occurs when heavy call buying sparks a feedback loop in a stock, causing a rapid price advance. Though gamma squeezes cause rapid price advances, they are very risky to navigate.
See More Zacks Research for These Tickers
Normally $25 each - click below to receive one report FREE:
Image: Bigstock
What is a Gamma Squeeze? Understand the GameStop Play
“Gamma squeeze” is a relatively obscure term understood by experienced options traders. However, as of late, gamma squeezes are occurring more often than ever on Wall Street, so investors should educate themselves on the term.
What is a Gamma Squeeze?
In options markets, a gamma squeeze occurs when a stock swiftly rallies due to market maker hedging.
Options 101
To clearly understand gamma squeezes, investors must first have a handle on the inner workings of the options market. Options are financial derivatives that provide the owner the right, but not the obligation, to buy (call options) or sell (put options) of an underlying asset at a specified price before the expiration date.
Options Greeks
Though options are roughly correlated to the underlying asset’s price movements, options pricing is a bit more complex than equity pricing, for example. Option Greeks are a group of gauges that allow traders to understand how an option price is expected to change. However, it is critical for investors to understand that equities can impact options pricing and vice versa.
Delta
Delta measures how much an option price will change with every $1 move in the stock. Envision delta as the speedometer on your car. If your speedometer displays 40 miles per hour, that would be akin to your delta.
Gamma
Gamma is a metric that gauges the rate of change in the delta relative to every $1 move in the stock. For example, 100 shares of stock would have a 0 gamma and a 100 delta. Using the same example from earlier, if you speed up from 40 to 50 MPH, your gamma is 10. Gamma represents the change in delta.
Anatomy of a Gamma Squeeze: The GameStop Example
To explain a gamma squeeze, I will use the most famous example, GameStop ((GME - Free Report) ). I will also use metaphors to make the concept easy to understand. A gamma squeeze has four ingredients:
1. A Flurry of Call Buying: Traders buy a plethora of out-of-the-money call options. In the case of GameStop, the call buying was largely attributed to speculative retail investors who were members of the Reddit ((RDDT - Free Report) ) “subreddit” community called “r/WallStreetBets.” Community members coalesced to take advantage of the high short squeeze in GME and orchestrate a short squeeze.
2. Hedging Market Makers: Market makers are mostly Wall Street firms that provide liquidity to various markets, including the options market. In the options market, these entities provide liquidity by allowing traders to buy and sell options. They continuously quote buy and sell prices for options, better known as the bid-ask spread. Market makers implement historical stats and probability to profit from the difference between the bid and ask.
Fuel added to the Fire: When a market maker sells call options, they need to hedge by purchasing underlying shares because if the stock rises, they must deliver stock to option buyers. In other words, the more call options market makers sell, the more stock they need to buy. In the case of GME, the number of shares market makers needed to purchase was dramatically increased due to the increased popularity of 0DTE (zero days until expiration) options and far out-of-the-money calls.
3. Price Momentum and Feedback Loop: The shares purchased by market makers drive the stock higher. A rising stock price leads to a higher delta, forcing market makers to buy even more stock to manage risk through hedging. The chain of events sparks a feedback loop that includes:
A. Heavy Call Buying
B. Rapidly Increasing Delta
C. Stock Purchases by Market Makers to Hedge Positions and Manage Risk
Beyond the feedback loop mentioned, GameStop’s gamma squeeze in late 2020 was particularly extreme. Short sellers were forced to cover as the stock rose, and retail investors jumped on board to take speculative bets. Remember, at the time, many people were confined to their homes and flush with cash thanks to stimulus checks handed out during the COVID-19 pandemic. Furthermore, discount broker Robinhood ((HOOD - Free Report) ) had just become the first stock broker to employ zero-commission equities trading.
Image Source: Zacks Investment Research
Gamma Squeezes: A Word of Caution
Investors who decide to trade a gamma squeeze should be extremely careful. In fact, for most investors, spectating is the best course of action because:
Hyper Volatility: Gamma squeezes result in massive price ranges and overnight gaps.
Traders are not in Control: GME and other gamma squeezes like AMC ((AMC - Free Report) ) add risk to the equation that is impossible for traders to account for. For instance, Keith Gill, known in online trading circles as “Roaring Kitty,” rose to fame on the r/WallStreetBets subreddit. Social media posts by Gill can often move a stock like GME by 20% or more. Furthermore, stock exchanges and regulators can halt stock for various reasons
Gamma Squeezes are Not Sustainable: Gamma squeezes are unsustainable because they are a phenomenon that is detached from fundamentals. Like a game of musical chairs, latecomers bear the brunt of the pain when the stock crashes downward.
Bottom Line
A gamma squeeze occurs when heavy call buying sparks a feedback loop in a stock, causing a rapid price advance. Though gamma squeezes cause rapid price advances, they are very risky to navigate.