What does Gamma Squeeze mean?
After selling call options on a particular stock, market makers who are exposed to negative (short) gamma and negative (short) delta may experience a gamma squeeze.
Let’s simplify this as it can all sound confusing:
Delta – this shows the anticipated change in an option’s price in reaction to a $1 change in the underlying stock price. Because the option’s price would increase in tandem with an increase in stock price (delta), a positive delta denotes a long position in the market, whilst a negative delta denotes a short position.
Gamma – Gamma simply refers to the rate of change of delta and is the first derivative of delta. Gamma values are greatest for options that are at-the-money and lowest for those that are distant OTM or ITM (in-the-money).
Long gamma – indicates that the delta of an option position will increase when the share price increases and vice versa.
Short gamma – indicates that a position’s delta will decrease as the share price rises and vice versa.
The graph up top depicts the relationship between call delta values and stock prices. Around ATM choices, which represent the pace of change and hence gamma itself, the slope is highest. Gamma is lowest for deep OTM and ITM options, as seen by the flatter deep OTM option curve.
DELTA AND GAMMA GREEK CALLS TABLE
| DIRECTION | DELTA | GAMMA |
|---|---|---|
| Long Call | + | + |
| Short Call | – | – |
WHAT CAUSES A GAMMA SQUEEZE AND HOW CAN YOU PREVENT IT?
There are several significant contributors to a gamma squeeze, yet no one element is responsible for the phenomenon:
- Stock call options with a short expiration date.
- The delta hedge.
- Low liquidity shares.
Investors should adhere to two straightforward criteria in order to prevent the detrimental impacts of a gamma squeeze:
- While the gamma squeeze is happening, avoid shorting stocks in an attempt to predict peaks.
- Avoid trading in call options.
SHORT SQUEEZE VS. GAMMA SQUEEZE
Short sellers contribute to the upward pressure by joining the purchasing frenzy in an effort to reduce losses and close out their positions when buyers flood the market and drive the share price higher. A short squeeze entails shorting or borrowing shares and buying it back at a later date.
On the other hand, a gamma squeeze includes options, and when market makers sell deeply out-of-the-money (OTM) options, they are forced to buy an increasing number of shares to hedge their exposure to rising share prices as the gamma of the option grows, which is why it is termed a gamma squeeze. The example following could make this more understandable.
Example of a Gamma Squeeze
The GameStop (GME) spectacle, which recently garnered headlines following a spectacular increase in its share price over a very short period of time (see chart below). Investors require a counterparty in order to buy call options on the GME. On the opposing side of the deal, the market maker (counterparty) often adopts this stance. Market makers often don’t care about changes in the price of the underlying stock since they earn money on the deal itself (spread). Therefore, should the price of the underlying stock increase, adding more long calls entails risk for the market maker. Market makers visit the market and buy the relevant stake in order to protect themselves from such unfavorable fluctuations.
In the end, this is what led to the rapid rise in the price of the GME share. Theoretically, this event combined a short squeeze with a gamma squeeze, with the latter adding gasoline to the fire.
GameStop Corp. vs the S&P 500 Index
