A Gamma squeeze happens when stock traders are compelled to buy a stock due to changes in an underlying stock price. This results in a stock rise.
Market makers who sell options possibly need to deliver the underlying stock. To reduce risk, they regularly buy or sell shares in the underlying stock. In a situation whereby the cost of buying exceeds what was planned for, investors are at the risk of facing steep losses especially new buyers.
For instance, a call option offers traders the chance to purchase a stock at a particular timeframe. If there are more buying activities and it becomes excessive for these call options, a Gamma Squeeze can take place. This boost higher prices and creates an upward spiral.
To further understand the concept of Gamma Squeeze, let us take a look at major terminologies that would aid our learning:
- What is an Underlying Stock
- What are Call Options
- Market makers
- Stock price and Strike price
What is an Underlying Stock and Stock Prices
Underlying in equities is the common stock that must be delivered when a warrant is exercised or when a convertible bond or convertible preferred shares is converted to common stock.
What are Call Options
It is a financial contract that gives traders the right to buy a stock. It can be perceived as a down payment for future purchases.
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A market maker is a broker-dealer who buys or sells specific security (stocks), at a notably quoted price. There is often more than one market maker in security and they bid against each other helping the market place remain liquid.
Strike Price and Stock Price
Strike price can be referred to as the price in which the owner of an option can initiate a contract. On the other hand, a Stock Price can be referred to as the last transaction price of at least a single share of the underlying security.
- What is Squeeze in Investing?
- Short Squeeze Vs Gamma Squeeze
- Gamma Squeeze Explained
- How a Gamma Squeeze works with Stock Price
- Gamma Squeeze Examples
- What Triggers a Gamma Squeeze
- What Gamma Squeezes means for Investors
What is Squeeze in Investing?
In investment, a squeeze of any sort is referred to a fundamental change in the behavior of the market at large or an underlying stock that makes investors buy or sell shares of a stock to protect their original trading positions.
The outcome of a squeeze is primarily due to a rapid shift in stock prices because of unusual buying and selling of shares particularly for hedging or buying out of a trade that is no longer profitable.
Short Squeeze Vs Gamma Squeeze
A short squeeze is applicable to hedge funds and institutional investors that take short positions in stocks. A short position implies that an investor believes that the general direction of the company is downside by buying a put option.
A put option gives investors the chance to buy shares at a stock price beneath the market price, at a point, profit made on stocks are sold. However, in a short squeeze, equity price rises swiftly. This compels short sellers to protect their short positions by buying actual shares of the stock to catch the rising price as a hedge.
Gamma Squeeze Explained
Gamma Squeezes could occur in situations whereby there are more buying activities of short-dated call options for stocks in the stock market. This can viably make an upward spiral that could foster a buying call to trigger higher stock prices and end up in more call buying and higher stock prices.
Gamma as an investment term is associated with the “Greeks”. The Greeks are a bunch of terms used to express different positions in options trading. For instance, Delta explains the rate of changes of an options price correlates to the change in the underlying stock’s price. Gamma and Delta are relative as they measure how the latter changes as a stock’s price move up or down.
In addition, Gamma and Delta together with other Greeks can be utilized for determining what may happen to a stock’s price in the nearest future. It can also be used to establish the positions to take while trading options for a particular stock.
How a Gamma Squeeze works with stock price
Various conditions need to be met for a Gamma Squeeze to indicate or display in the market. Firstly, it manifests when investors make propositions about rising stock prices.
On a larger scale in stock, this prompts buying short-dated call options. A call option’s value increases when the underlying stock is associated with value increment or higher stock prices. Also, institutional investors selling the options find themselves in short positions.
If investors continue with pumping more money into call options, institutional investors can be propelled to buy more shares of the stock. It is a basic step for hedging against the short positions they find themselves in.
When an underlying stock’s price starts going up rapidly within a short timeframe, this is when the Gamma squeeze occurs. The continuous inflow of more buying actions can lead to a high share price. Therefore, investors that bought call options and sold after a significant pump at share price would amass profit while institutional investors who needed to protect their short positions may incur significant losses.
Gamma Squeeze Examples
AMC entertainment holdings (AMC) and Gamestop (GME) are noteworthy instances of enormous Gamma squeeze. Both AMC and GME encountered higher stock price earlier in the year (2021) as a result of the Gamma squeeze.
A lot of financial analysts concluded that GME’s stock value pump in January was based on a short squeeze. Some institutional investors predicted that Gamestop would fall in the stock price as they believed the business model was outmoded, then went ahead to short the stock, wanting to make a profit if the asset reduced in value.
At the point where retail investors were buying the stock in large volume, short sellers were compelled to leave their short positions and buy the stock, prompting a bullish ride in price which gamma squeeze plays its part in.
Hedge funds that gambled against GME had to close their sell positions as the shares of Gamestop continued to rise in price. GME has rallied up over 4,800% this year and.
In the case of AMC, it rose to exceed 1,200 within a year due to impacts from the Gamma squeeze. This was possible because investors were buying AMC stock as well as trading options which then led market makers to hedge their positions by buying the underlying stock.
What Triggers a Gamma Squeeze?
It is triggered when a stock with a massive short position is projected to rise by a significant amount. However, this projection is in the opposite direction of the current short positions. Therefore, rather than incurring shares, bullish investors also need to purchase short-dated call options as the call ratio turns out to be progressively inflated.
What Gamma Squeezes means for Investors
It could be a profitable investment opportunity and at the same time be a risky situation. It depends on the driving factors of a short squeeze and subsequent gamma squeeze which could last for days or weeks. Due to this, timing has a significant influence in determining if it would be profitable or massive losses.
When a Gamma squeeze rallies to its peak, price reversals become imminent and may occur rapidly and you might experience a lofty decrease in share price. Hence, trading options may not be suitable for investors that are unable to tolerate risk.
Gamma squeeze can set out opportunities for investors when they form but it is important to be aware of the high risk involved. Practically, the market volatility in such a situation is usually high.
The Gamestop experience is a typical example of how influential timing is when endeavoring to exploit this sort of strategy.
Take time out to conduct In-depth research on a company and analyze its share ownership. If your findings are contrary to your beliefs then initiating a position increases the chances of a Gamma Squeeze occurring.
Experiences with Gamestop and AMC in the context of the subject matter should be seen as an exception instead of the rule.
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Is Gamma Squeeze good?
It depends on how an investor weighs the opportunity it presents. It can result in massive profit and can result in steep losses because of high volatility. Risk tolerance is also deciding factor. An individual Investor trading the squeeze is doing that at his own risk based on personal data and research.
How long does a Gamma squeeze last?
There is no specific time. It could last a short period or a long period depending on its driving factors.
Can Gamma squeeze work both ways?
Yes, it can. However, a squeeze in a downward direction from a Gamma driven selling is usually minimal unlike the buying pressure of the upward direction.
How do you measure Gamma Options?
Gamma measures the difference in option’s delta divided by changes in the underlying price.