A squeeze in finance is a rapid and sudden change in the prices of an underlying asset that prompts investors to change their investing actions that they would not have otherwise had to do. When there is such a rapid change in prices, there will be investors who will feel ‘squeezed’ and have to take action to prevent being ‘choked’ in the market. A gamma squeeze is an example of this scenario and is associated with the options trading market. It happens when options market makers seek to cover or hedge their exposure, and their activity can lead to higher stock prices in the equities market.

Open a Demo account to practice what you’ve learned or a Real account to start trading today!

Register Now Or Try Free Demo

Gamma Squeeze Explained

To understand gamma squeeze, it is imperative to know about options trading, specifically call options and delta.

As Jim Cramer, CNBC’s Mad Money host, said: “The gamma squeeze is a significant driver in these unprecedented stock moves. Retail traders buying short-term call options are causing market makers to buy the underlying stock to hedge, pushing prices even higher.”

Call options are derivative contracts that give investors the right to buy an agreed amount of an asset at a specified price (strike price) by a specific date. Call options earn investors profits if the underlying stock price is above the strike price by expiry. An option contract is typically made with a market maker who provides liquidity and is willing to buy or sell different contracts to profit from the premium or transaction costs.

When many investors buy call options, it essentially means that the market maker is placing a substantial short position on the underlying asset. This exposes the market makers to massive risk if an upward directional move happens and many investors’ contracts expire in the money.

The risk is even higher for the market makers because options are leveraged products. Market makers will buy the underlying stock to hedge against their short position to counter this risk. This buying activity serves as another tailwind for the underlying stock, pushing prices higher and higher. This sets the stage for a gamma squeeze.

But to further understand the squeeze, it is vital to understand the terms’ delta’ and ‘gamma’. These ‘Greeks‘ usually help understand an option contract’s risks. Delta shows how much the price of an option contract is expected to change when the underlying stock or security price changes by $1 (or one pip in the case of FX pairs). Call options have positive delta values from 0 to 1. Delta determines whether an option contract is likely to expire in the money.

Out-of-the-money options will have a delta closer to 0, and at-the-money options will have a delta close to 0.5, whereas deep-in-the-money options will have a delta close to 1. The higher the delta, the wider the price change. A delta of 0.4 means that the option premium will change by $0.4 for every $1 change in the underlying stock price.

On the other hand, gamma is the rate at which an option’s delta changes. Gamma is at the highest for at-the-money options, progressively decreasing as delta approaches 0 or 1.

A gamma squeeze then happens when the underlying asset price rises rapidly within a short period. This forces market makers to cover their positions, leading to a significant market spike. A gamma squeeze illustrates how activity in the options market can influence volatility in the equities market.

Gamma Squeeze vs Short Squeeze

Gamma squeeze is a scenario similar to a short squeeze, but the difference lies in whom the impact is on. A gamma squeeze is when stock prices rise, and option market makers are forced to exit their short positions. On the other hand, a short squeeze impacts a trader who went short in the equities market and is forced to exit the position. In both scenarios, though, a sharp rise in prices forces either the market maker or trader to alter their investment plans in the market.

Emerging Trends in Gamma Squeezes

Rise of Retail Investors and Social Media Influence

Crowd-Sourced Trading Strategies: Platforms like Reddit’s r/WallStreetBets have enabled retail investors to coordinate trading strategies, amplifying their market impact. For example, the GameStop (GME) gamma squeeze in early 2021 was significantly driven by retail investors collectively buying call options.

Democratisation of Trading Tools: Easy access to options trading through mobile apps has lowered the barriers for retail trader participation in complex trading strategies.

Increased Options Market Activity

Surge in Short-Dated Options Trading: There is a growing trend towards trading weekly and even daily options, which have higher gamma sensitivity. Higher gamma in short-dated options means that market makers must adjust their hedging more aggressively, amplifying price movements.

Zero-Day-to-Expiry (0DTE) Options: The popularity of options that expire within the same day has introduced new dynamics to gamma squeezes.

Enhanced Market Volatility

Feedback Loops: Gamma squeezes can create positive feedback loops where rising prices lead to more buying, further pushing up prices.

Market Instability Risks: The amplification of price movements increases volatility, which can have broader implications for market stability.

Algorithmic Trading and Automation

Algorithmic Hedging: Market makers increasingly rely on algorithms to hedge their positions, which can accelerate the pace of gamma-induced buying or selling.

Speed of Execution: Automated systems can react faster to market changes, intensifying the effects of a gamma squeeze.

Regulatory Scrutiny and Policy Responses

Increased Oversight: Regulatory bodies are paying closer attention to the impact of options trading on market volatility. For example, the SEC (U.S. Securities and Exchange Commission) has been examining the role of social media and retail trading in market dynamics.

Potential Policy Changes: Discussions around implementing measures to curb excessive speculation and improve transparency in options markets are ongoing.

Recent Gamma Squeeze Examples

Here are some recent examples of a gamma squeeze in the markets:

AMC Entertainment

AMC Entertainment is an American theatre exhibition company that has faced negative fundamentals recently. Its business was significantly hindered further during the 2020 COVID-19 pandemic when populations were kept indoors. In January 2021, the AMC stock traded as low as $2, with the company speculated to go bankrupt.

But an investing group on a popular social platform, Reddit, rallied investors to ‘punish’ big hedge funds that seek to profit from companies experiencing tough times. Alongside buys in the stock market, investors also purchased multiple call options, with market makers taking the opposite trade. At the height of the gamma squeeze in June 2021, AMC traded as high as $62. After the gamma squeeze, however, prices quickly collapsed to normal levels.

GameStop

Like AMC, GameStop (a video game and entertainment merchandise retailer) faced increasing short pressure after speculating that its 2020 performance was abysmal. Its stock traded below $20 before the turn of the year, and many traders and two large hedge funds were reportedly shorting it.

However, Reddit investors aggressively bought the stock and accumulated extensive call options that simultaneously caused both a short squeeze and a gamma squeeze. By the end of January 2021, GameStop stock traded as high as $340 but quickly tumbled below $50 before the end of February 2021.

SoftBank

In August 2020, SoftBank (a Japanese tech conglomerate) bought out the money options of US technology companies such as Salesforce, Apple, Tesla, Alphabet, and Amazon. The company’s actions triggered a gamma squeeze in the markets that caused several stocks of the underlying tech companies to post unprecedented price gains within a short time (in August alone). For instance, Salesforce stock jumped over 26%, Tesla stock rallied over 74%, whereas Apple shot over 21%.

Volkswagen Short Squeeze (2008)

Volkswagen briefly became the world’s most valuable company when its share price skyrocketed due to a short squeeze exacerbated by gamma effects. This happened due to Porsche’s announcement of increased ownership, which led to a scramble among short sellers and options market hedging activities.

Lessons Learned:

  • Market Structure Vulnerabilities – A limited free float can intensify squeezes.
  • Regulatory Gaps – The event exposed the need for better disclosure requirements regarding ownership stakes.

Key Takeaways and Strategies

  • Risk Awareness: Understand that gamma squeezes can lead to rapid and unpredictable price movements. This can increase both potential gains and losses.
  • Due Diligence: Evaluate the levels of options activity and short interest in the asset as part of your investment/trading analysis.
  • Diversification: Mitigate risks associated with gamma squeezes by maintaining a diversified portfolio.

Gamma squeezes represent a significant force in today’s financial markets, driven by evolving trading behaviours and technological advancements. The emerging trends highlight the growing influence of retail investors, the impact of short-dated options, and the role of automation in trading. Historical events like those involving GameStop, Volkswagen, and even Tesla offer valuable lessons on the risks and implications of gamma squeezes.

Understanding these dynamics is crucial for all market participants. Investors and traders can better navigate market volatility by incorporating options activity analysis into their strategies. Market makers and regulators can work towards enhancing market stability through improved risk management practices and regulatory frameworks.

As the financial landscape continues to evolve, it is prudent to stay informed about phenomena like gamma squeezes to enhance decision-making regarding your investments.

Practical Steps for Identifying Gamma Squeeze Opportunities

Identifying potential gamma squeeze opportunities involves analysing various market factors. Particularly, it is important to observe activity in the options market that could lead to a rapid increase in a stock’s price due to the dynamics of options hedging. Below are practical steps to help you identify such opportunities:

1. Monitor Unusual Options Activity

High Volume of Call Options

  • Action: Look for stocks exhibiting unusually high volumes of call options trading, especially those with near-term expirations.
  • Rationale: A surge in call option buying can force market makers to hedge by purchasing the underlying stock, which contributes to a gamma squeeze.

Significant Out-of-the-Money (OTM) Options Trading

  • Action: Pay attention to increased trading in OTM call options.
  • Rationale: Large purchases of OTM options can lead to significant hedging requirements for market makers as the asset price approaches the strike price.

2. Analyse Open Interest and Changes

Rising Open Interest in Call Options

  • Action: Track increases in open interest for call options at various strike prices.
  • Rationale: Growing open interest indicates more positions are being opened, which can amplify the impact of hedging activities.

Concentration at Specific Strike Prices

  • Action: Identify strike prices with unusually high open interest.
  • Rationale: A high concentration can create key levels where gamma hedging activity intensifies as the stock price approaches these strikes.

3. Assess Implied Volatility (IV)

Increasing Implied Volatility

  • Action: Monitor the IV of options for sudden spikes.
  • Rationale: Rising IV suggests a growing demand for options, possibly indicating speculative activity that could lead to a gamma squeeze.

Volatility Skew

  • Action: Examine the IV across different strike prices for anomalies.
  • Rationale: A skew can reveal where the market anticipates significant price movements.

4. Examine Short Interest Data

High Short Interest Ratio

  • Action: Check the percentage of a company’s floated shares that are sold short.
  • Rationale: Stocks with high short interest are more susceptible to squeezes as short sellers may rush to cover positions, adding upward pressure on the stock price.

Days to Cover

  • Action: Calculate the days to cover by dividing the total short interest by the average daily trading volume.
  • Rationale: A higher number indicates that it would take longer for short sellers to exit their positions, potentially exacerbating a squeeze.

5. Look for Upcoming Catalysts

Earnings Announcements

  • Action: Note any impending earnings releases or corporate events.
  • Rationale: Such events can increase uncertainty and options activity as traders speculate on outcomes.

Product Launches or News Releases

  • Action: Stay updated on company-specific news that could impact stock prices.
  • Rationale: Positive news can trigger increased bullish options activity.

6. Observe Market Maker Hedging Behaviour

Delta and Gamma Exposure

  • Action: Estimate the aggregate delta and gamma exposure of market makers based on open options positions.
  • Rationale: High gamma exposure means that small moves in the stock price can lead to significant hedging activity.

Hedging Requirements

  • Action: Assess how changes in the stock price might force market makers to adjust their hedges.
  • Rationale: Understanding these dynamics can help predict potential buying or selling pressure.

7. Monitor Social Media and Trading Forums

Retail Investor Sentiment

  • Action: Follow platforms like Reddit’s r/WallStreetBets, Twitter, and other forums.
  • Rationale: Collective actions by retail investors can drive significant options activity.

Unusual Buzz Around Specific Stocks

  • Action: Look for spikes in mentions or discussions about a particular stock.
  • Rationale: Increased attention may precede heightened trading activity.

8. Evaluate Trading Volume and Liquidity

Unusual Trading Volume

  • Action: Compare current trading volumes to average volumes.
  • Rationale: A significant increase can signal heightened interest and potential for volatility.

Low Float Stocks

  • Action: Identify stocks with a limited number of shares available for trading.
  • Rationale: Stocks with low floats are more susceptible to price swings due to supply and demand imbalances.

9. Review Historical Price and Options Activity

Previous Gamma Squeezes

  • Action: Analyse the stock’s history for past squeezes or volatility spikes.
  • Rationale: Past behaviour can indicate susceptibility to future squeezes.

Patterns in Price Movements

  • Action: Look for recurring patterns or correlations between options activity and stock price movements.
  • Rationale: Identifying patterns can improve predictive accuracy.

10. Utilise Analytical Tools and Platforms

Options Flow Software

  • Action: Use specialised tools that track real-time options flow and identify unusual activity.
  • Rationale: These tools can provide insights that are not readily apparent from standard data sources.

Data Visualisation

  • Action: Employ charting software to visualise options data alongside stock price movements.
  • Rationale: Visual representations can help in spotting trends and anomalies.

Important Considerations

  • Risk Management
    • Volatility Awareness: Gamma squeezes can cause extreme volatility, so be prepared for rapid price movements in both directions.
    • Position Sizing: Manage your exposure by adjusting position sizes according to your risk tolerance.
  • Due Diligence
    • Fundamental Analysis: Don’t rely solely on options activity and make sure to assess the company’s financial health and growth prospects.
    • Professional Advice: Consider consulting financial advisors or professionals for personalised guidance.
  • Stay Informed
    • Market News: Keep abreast of broader market conditions that could influence stocks and options markets.
    • Education: Continuously educate yourself about options mechanics and market dynamics.

Conclusion

Identifying gamma squeeze opportunities involves a multifaceted analysis of options market dynamics, stock-specific factors, and market sentiment. By systematically applying the steps outlined above, you can enhance your ability to spot potential gamma squeezes. However, it’s crucial to approach such opportunities with caution due to the inherent risks and volatility involved.

AvaTrade provides a stable and advanced trading platform for trading gamma squeezes efficiently. Browse the AvaTrade education section and learn more about taking advantage of gamma squeezes in the market.

Open a Demo account to practice what you’ve learned or a Real account to start trading today!

Register Now Or Try Free Demo

FAQ

  • What is a Gamma Squeeze?

    A gamma squeeze happens when stock prices rapidly rise in the market. This triggers buying call options in large volumes, forcing market makers to cover their positions by buying the underlying stock. This can lead to a significant spike in the stock price.

  • How Long Does a Gamma Squeeze Last?

    This depends on how many outstanding options the market maker needs to hedge against. Typically, a short squeeze lasts just a few days, but in extreme cases, it can go on for a few weeks.

** Disclaimer –While due research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.