Stock prices regularly fluctuate in response to new information. As a result, it’s not uncommon for a particular company’s share value to triple or fall by the same amount in the space of a month.
When this happens, investors often wind up making changes that they haven’t planned, leading to so-called “squeezes” of the market.
So, what is a gamma squeeze?
Buckle up to know what gamma squeeze means and how you can potentially take advantage of it. Although such squeezes are risky, they can also offer excellent opportunities to investors.
Gamma Squeeze Explained
What is a gamma squeeze? In trading and investing, the Greek letter “gamma” refers to the rate of change between an option’s delta and the underlying asset’s price.
Delta is simply a ratio that compares the change in the price of an asset to the change in the price of its derivative.
Suppose, you have marketable security, such as a stock option, with a delta value of 0.85. If the underlying value of the stock rises by $1, that implies that the option will increase by $0.85.
Delta can also be negative. For instance, a delta of -0.33 implies that a rise in the value of the underlying asset by $1 will lead to a fall in the value of the option of $0.33.
If delta is the first derivative, gamma is the second. It measures the rate of change in the rate of change of the option. It is the degree of convexity inherent in the derivative’s value. That is how sensitive the security to changes in the underlying value of the asset is (and how does that change as the asset changes?)
Gamma squeeze occurs when the value of gamma changes in a way that affects investors’ decision-making criteria.
In general, delta usually gives a picture of how the underlying asset price will affect the option price changes. Conversely, gamma provides more long-term information about how the option’s delta will change in response to underlying asset prices.
Gamma approaches zero when an option gets deep in or out of the money. Gamma is at its largest when the option is near or at the money. These changes cause investors to enter and exit their positions at a higher rate.
What Causes a Gamma Squeeze?
Gamma squeeze usually occurs when market makers buy or sell their positions in a short space of time. The increase in demand creates a surge in the price of the underlying shares, causing abrupt changes in the price that don’t relate to the intrinsic value of the asset (or the company behind them).
What Is a Gamma Squeeze vs a Short Squeeze?
Gamma squeezes can look a lot like short squeezes, but they are slightly different. Unlike short squeezes, gamma squeezes are caused by market makers, not traders. Gamma squeezes are caused by erratic price movements and large trading volumes, leading market makers to exit trades.
Has a Gamma Squeeze Ever Happened?
A great example of a gamma squeeze is the GameStop stock saga. As attention for GameStop grew, so did the demand for call options. This process forced option sellers to hedge their risk by buying shares of the company, pushing prices even higher — something you can learn about on a gamma squeeze wiki page.
Another example is the Tesla gamma squeeze. The firm’s stock price skyrocketed in Q3 2021 before plunging back to more realistic figures by Q4.
Interestingly, the largest short squeeze in history wasn’t GameStop (although that came close). Instead, it was VW Group stock during the middle of the 2008 crisis. Hedge funds, reports suggest, lost around $30 billion collectively.
What Are Calls in Stocks?
Simply put, a call option is a financial contract that gives the option buyer the right to buy a stock at a specified price within a predefined time.
How a Gamma Squeeze Works
How Long Does a Gamma Squeeze Last?
Gamma squeezes typically last a day or two. In certain cases, they may continue for a month or more. Usually, they only end when the stock price rises above the strike price. At this point, the market maker is fully hedged, meaning they don’t need to buy more shares.
Can Gamma Squeeze Both Ways?
Yes, it can. For instance, market makers are highly motivated to sell a stock when its price is falling to hedge their exposure, causing further declines in the price.
What Gamma Squeezes Mean for Investors
While gamma squeezes may be risky, they can also be rewarding for investors.
Depending on what drives a gamma squeeze, they can end in a matter of days or linger on for months. Therefore, timing plays a paramount role in determining whether a gamma squeeze leads to a profit or loss for your investment portfolio.
Generally, options trading is riskier than mutual funds or ETFs. However, investors who knew how to buy AMC stock during the gamma squeeze managed to make a lot of money. Then, as the price rose, they were free to sell their shares and take home the profits.
Investment Tips
Whether you can take advantage of a gamma squeeze depends on your risk tolerance. While you can make a lot of money, you can lose it too.
You can use a gamma squeeze indicator as an early warning sign that such an event occurs. A gamma squeeze chart will show you how the underlying gamma changes over time.
You can then explore a gamma squeeze stock list and see whether there are any stocks that you want to buy. If you believe that investors have many short-term options connected to the stock coming due and that market participant needs to buy stocks to hedge against that, you might expect increases in the underlying price. You could, therefore, invest in the stock now in a speculative way to benefit from higher prices in the future.
In Conclusion
A gamma squeeze can provide an excellent opportunity for investors, but it can also be risky. If you’re considering taking advantage of this trading strategy, you should keep in mind that timing is of utmost importance here, as share prices increase unexpectedly. Additionally, reversals can happen quickly too.
