Explaining A Gamma Squeeze In Layman’s Terms

A Gamma Squeeze has been a relatively new term that has been floated around the Stock Market as of late. It's been made popular as the best way to describe the crazy action in GameStop (GME) and AMC over the last few years.

GameStop's (GME) meteoric rise, blasting all the way to the Moon not once but twice has caught the attention of not just the investors and traders, but everyone across the world. Behind every attempt to explain the price action of GameStop (GME) always includes the words "Gamma Squeeze". The question I'm sure many have is what exactly is a Gamma Squeeze?

 
In simplest of terms, a squeeze refers to the inefficiency of a market that allows the prices of a particular company to rise rapidly. It happens because there are not sufficient shares to be sold to the buyers. 

In a classic short squeeze, investors who have recently sold shares short of a particular company are forced to buy the same shares to cover as they see prices of shares increasing at a frantic pace (also caused by a Margin Call initiated by the underlying broker). This leads to stock prices going up even further. Gamma Squeeze is similar to a short squeeze but goes a step further than the short squeeze, as it involves the hedging of call options.

Gamma Squeeze occurs when traders indulge in large quantities of options call buying. Traders tend to prefer buying call options as it is a cheaper alternative compared to buying shares of a company. Due to the inherited leveraged nature of options, returns when betting in the right direction tend to be magnitudes more profitable than directly buying shares. However, buying call options have their own set of dangers. 

It is theorized Gamma Squeezes occur when large amounts of options calls are purchased, As a result, Market Makers or Institutional Investors (who allegedly are at the end of these trades) are now short the stock. As the stock price slowly rises (mostly unexpectedly), it puts those short in a risky position. In order to mitigate the risk those short attempt to hedge their short position (since they lose when prices go up) by buying shares directly, this results in an even faster exponential increase in price, thus a Gamma Squeeze!

The trick to a Gamma Squeeze is many speculators are buying cheap out-of-the-money options, where simply spending $1000 dollars can result in the short side having to spend millions buying shares directly to hedge. You can imagine what this can do to a stock that already has a huge short interest as seen with GameStop, where options are severely mispriced. Going forward finding Gamma Squeeze opportunities will be a new way to generate market-beating returns (we have now seen in $AMC and $GME).

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