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The Gamma Squeeze: What Is It?

Jun 04, 2023 By Susan Kelly

Squeezing occurs, as previously indicated when there is sudden upward pressure on stock prices. When stock prices fluctuate rapidly, investors who currently hold the stock may experience a feeling of being "squeezed" and decide to sell or buy.

There is a subset of stock squeezes known as short squeezes. An increase in stock price, known as a "short squeeze," can prompt short sellers to repurchase their holdings. When investors short a company, they bet the stock price decreases rather than rises. Although stock prices may rise after a short squeeze, this increase in value may not be sustainable in the long run.

When there is a rush for call options on a particular stock but only a short time before they expire, the result is a gamma squeeze. Call buying can lead to higher stock prices, leading to even more call buying, and so on, in an escalating cycle.

The Greeks used gamma to describe a risk factor in financial markets. A vocabulary known as "the Greeks" is used in the options market to define distinct positions. For instance, delta describes the relationship between the rate of change in an options price and the rate of change in the underlying stock price. The gamma gauges the change in delta as a stock's price goes up or down. Hence it is closely tied to the delta.

Here's a basic explanation in case it sounds like Greek to you. Combining gamma and delta with the other Greeks can help you forecast the future of a stock's price. This information can then be utilised to adopt a stance when trading options on a certain stock.

Recent Examples of the Gamma Squeeze

Recent market gamma squeezes include the following:

1. AMC Entertainment

American movie theatre exhibitor AMC Entertainment has seen its financials deteriorate in recent years. During the 2020 COVID-19 epidemic, when people stayed inside out of fear about their health, its business was severely hampered. AMC shares dropped to $2 in January 2021 on rumours that the corporation was about to collapse.

However, a group of Reddit investors have banded together to "punish" large hedge funds that attempt to benefit from struggling businesses. Investors bought stocks and many call options, with market makers making the inverse move. The gamma squeeze peaked in June of 2021 when AMC reached a price of $62. However, following the gamma squeeze, prices immediately returned to normal.

2. GameStop

The video game and entertainment products retailer GameStop, like AMC, came under rising short pressure due to predictions that its 2020 performance would be dismal. Before the new year began, its stock was trading for less than $20, and numerous investors and at least two significant hedge funds were rumoured to be shorting the stock.

Reddit investors, however, bought the stock quickly and amassed many call options, leading to a short and gamma squeeze at the same time. GameStop stock peaked at $340 at the end of January 2021 and dropped to below $50 by the end of February 2021.

Gamma Squeeze and Short Squeeze

The primary focus of a short squeeze is on short sellers closing out their short position by purchasing additional shares of the company's stock. Squeezing the price of a stock can be induced by purchasing pressure on the underlying stock or buying options. When short sellers buy genuine shares to close out their short positions, they usually do so at a loss and are not hedging their positions with options contracts.

In contrast, a gamma squeeze focuses on purchasing and selling call options. Gamma squeezes cause more severe price spikes than short squeezes, but they can cease if the stock price surpasses the strike price of the call options, albeit not before a lot of havoc is caused. This is because once the market maker has achieved full hedging, it no longer needs to acquire further shares of the underlying stock. Price increases during gamma squeezes might spike suddenly, but then peter out.

A Synopsis of Gamma Squeeze

Compared to short squeezes, gamma squeezes tend to be much more intense and shorter in duration. Gamma squeezes focus on options contracts, whereas short squeezes involve short-sellers covering their positions by purchasing shares. Traders will not only purchase common shares but also call options that are far from the money. To counteract this risk, short traders will also buy call options. Both of these factors cause market makers to ramp up their stock purchases, driving higher prices.

In the stock market, gamma squeezes are extremely rare and typically end after the option contracts' strike price is reached. Meme stocks AMC and GameStop saw well-documented gamma squeezes in 2021.

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