The term "Gamma Squeeze" has recently emerged in stock market discussions, especially with the extraordinary price movements of "meme stocks" like GameStop (GME) and AMC. This concept gained attention as a way to explain the significant and unexpected surges in these stocks' prices.
GameStop (GME), in particular, has seen a remarkable turnaround from near bankruptcy to achieving record-high stock prices, not just once but multiple times. This dramatic shift has captured the imagination of many retail traders, leading to widespread speculation and investment. Gamma Squeeze often comes up in discussions trying to make sense of GameStop's unexpected stock performance.
But what does Gamma Squeeze mean? In short, it refers to a situation in the stock market where the rapid escalation in a company's stock price is caused by market inefficiencies, particularly due to a shortage of available shares for sale. This scarcity of shares can lead to a rapid increase in the stock's price, which is what we often see in meme stocks.
What is a Short Gamma Squeeze?
As mentioned above, a Gamma Squeeze is a stock market phenomenon that occurs when the price of a stock rapidly increases due to options trading. It usually happens with stocks that have a significant amount of their options being bought.
Here's a breakdown of how it works:
1. Options Trading: In the stock market, options give traders the right (but not the obligation) to buy or sell a stock at a predetermined price. When traders buy many call options (bets that the stock price will go up), the sellers of these options (often market makers or institutional traders) hedge their risk by buying the underlying stock.
2. Delta Hedging: The amount of the underlying stock that option sellers buy to hedge is determined by the option's delta, a measure of how much the price of an option is expected to move based on a $1 change in the underlying stock. As the stock price increases, the delta increases, and option sellers have to buy more of the stock to stay hedged. This is really the Gamma Squeeze gets really juicy, with Market Makers having to buy more shares to stay hedged.
3. The Gamma Effect: Gamma measures the rate of change of delta. When a stock has a high gamma, its delta can change rapidly, leading to more buying of the stock by option sellers. This buying can drive the stock's price even higher.
4. The Squeeze: As the stock price goes up due to delta hedging, more call options go 'in the money' (become profitable), leading to more buying of the stock for hedging. This cycle can create a feedback loop where the rising stock price leads to more buying, which in turn pushes the stock price even higher, and so on. This is the Gamma Squeeze.
Conclusion
Hopefully, by the end of this article, you will have a better understanding of what a Gamma Squeeze is. To sum up, it's an intriguing event in the stock market, highlighted by the rapid rise in the prices of stocks like GameStop (GME) and AMC. This happens due to how options trading affects stock prices, especially when many investors buy options that bet on a stock's price going up. When this occurs, it can lead to a cycle where the stock price keeps climbing higher, parabolically.GameStop's significant price increase is a key example of a Gamma Squeeze. This situation shows how groups of regular investors can influence the stock market in big ways, sometimes leading to huge losses for professional investors and market makers who bet against these stocks. Understanding a Gamma Squeeze is important for anyone interested in the stock market, as it reveals a new side of trading where traditional rules don't always apply.