Author: Doumkou Stefani
A gamma squeeze occurs when heavy buying of call options creates a chain reaction that pushes a stock’s price up rapidly. This happens because market makers—who sell the options—must buy more shares of the stock to protect themselves as prices rise, creating a loop that accelerates the price increase. Let’s look at each part of this process more closely, including how call options work, the role of market makers, and the hidden connections through delta and gamma that make a gamma squeeze possible.
Understanding Call Options
A call option is a contract that lets investors buy a stock at a set price in the future. Investors buy call options when they believe a stock’s price will go up. If the stock price goes above the set price (strike price) by the option’s expiration, the call option becomes valuable, letting investors profit.
Market Makers and Their Role
Market makers are companies that sell these call options. They provide the contracts and help keep the market moving. When lots of investors buy call options, market makers take on a big risk: if the stock price goes up, they’ll have to cover those options, which could lead to big losses.
How Market Makers Manage Their Risk
To avoid losing money if the stock price rises, market makers start buying the stock itself. This is called hedging—they’re trying to balance their position, so they don’t lose money as the stock price changes.
The Delta and Gamma Connection
Delta is a number that tells us how much the option price is likely to change if the stock price moves by $1. Higher delta means bigger changes in the option’s price. On the other hand, Gamma measures how much delta itself changes. If the stock moves quickly, gamma gets larger, meaning the delta is changing fast, which means market makers need to buy even more stock to keep up.
Other Market Phenomena Similar to Gamma Squeezes
Several other phenomena in trading share similarities with gamma squeezes (Short Squeeze, Delta Squeeze, Vega Squeeze, Liquidity Squeeze, Momentum-Driven Price Spike etc). Each of these phenomena can create similar price effects to a gamma squeeze and are sometimes mistaken for it due to overlapping mechanics and price feedback loops. However, the distinct factor in a gamma squeeze is the specific options-driven hedging by market makers, which isn’t always present in these other cases.
Real-Life Examples of Gamma Squeezes
One of the most well-known gamma squeezes involved GameStop in early 2021. GameStop, a video game retailer, was under heavy short-selling pressure in 2020 due to poor performance, with its stock trading below $20. Many traders and two large hedge funds were betting against it. But Reddit investors began buying up the stock and call options aggressively, which triggered both a short squeeze and a gamma squeeze. By late January 2021, GameStop’s stock soared to $340, though it dropped back below $50 by the end of February. Gamma squeezes have also occurred in other stocks, such as AMC Entertainment, Softbank and others.
The Takeaway
Gamma squeezes are just one example of the forces that can drive sudden, dramatic price movements in the stock market. Knowing about gamma squeezes can help you understand the reasons behind unexpected stock surges and make more informed decisions. Remember that while these events can bring big opportunities, they also come with high risks—staying informed is the best way to navigate them. By understanding how gamma squeezes work, you’ll be better equipped to spot them and decide whether to watch from the sidelines or dive in. Happy trading!
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