What is a Gamma Squeeze in the Context of Stock Trading?
Posted on 12/22/2020
A “Gamma Squeeze” is an outcome based on an investor using many options to drive up the prices of select stocks due to option sellers needing to hedge their trades on the underlying stocks.
1. The squeeze can begin when a large investor, typically referred to as a whale, buys short-dated call options in a frenetic pace of stocks that they typically own.
2. The banks or brokers that sell the call options will typically buy the underlying stock so that they have very little or no net exposure. The more call options the investor buys, the more shares the brokers that sold the options will have to buy to ensure they are net flat. Brokers and dealers are motivated by the commissions and do not want to hold a trade either long or short.
3. The option purchases force the dealers to buy the underlying stock, which can push the share price higher. If pulled off, this creates a positive feedback loop, thus can drive underlying stock(s) price higher for a period of time. In a roundabout way, the dealers must buy more and more of the underlying. All said and done, this is the Gamma Squeeze.
More About Delta and Gamma
Delta quantifies the rate of change of the options price per the change in the underlying stock price. A delta of 0.50 means the option price will increase 50 cents for every US$ 1 in the stock. Delta is not a linear function, meaning it will not change proportionately with the stock price.
Gamma is the first derivative of delta and is used when trying to gauge the price movement of an option, relative to the amount it is in or out of the money. It essentially quantifies how Delta will change per the change in the stock price.