What’s riskier than a short squeeze? Meet the gamma squeeze

Mar 12 2021, 1:28 pm

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You can now comfortably explain what a short squeeze is in social situations, and you might have even contemplated buying some GameStop shares in January, but do you know what a gamma squeeze is?

If the phrase has you thinking about fraternities, you’re not wrong. The investing term is part of “The Greeks” trading system, which is used to describe various positions when trading options. Theta, vega, delta, and gamma all are different ways to measure an option’s investment risk and can be used to predict what might happen to a stock’s price over time.

This system ultimately helps investors decide what position to take when trading options in that stock. For example, delta can show investors how the shifts in an option’s price can correlate with the stock’s price. On the other hand, gamma measures the rate of change in an option’s delta over time.

If that all sounds like Greek to you, you’re not alone. A gamma squeeze is a complex investment strategy that can stump even the most seasoned of investors.

Combined with its highly volatile nature, it’s easy to see why this tactic is usually left to financial advisors or expert investors. But whether you’re an investing pro or brand new on the bandwagon, it can never hurt to be educated. Plus, the whole concept is pretty fascinating.

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What’s a squeeze again?

The perfect condition for a squeeze is when there’s a ton of buzz being made about where a stock’s price could be heading like there was on Reddit with GameStop.

This often happens when a company is struggling financially, and institutional hedge funds buy up stocks, ultimately betting on the stock to tank. When enough people join forces and decide to buy up these stocks, the price escalates quickly—in GameStop’s case, sending it up more than 400%.

A short squeeze happens when investors who are betting that certain stocks will perform poorly instead see rapid growth. This causes them to feel “squeezed” and they often scramble to buy the stocks back to minimize their losses, making the price skyrocket even higher.

How a gamma squeeze works

Let’s (try) and break this down. When a stock is rising in price, investors will often buy call options (a contract, between the buyer and the seller, to exchange a security at a set price) in large amounts.

If there are enough call options bought on a particular stock, it will trigger higher stock prices. Like short squeezing, this makes the price of the stock increase as more investors buy more calls.

A gamma squeeze is when investors buy more call options, which in turn makes institutional investors buy more shares of the stock as they try and hedge against the short, in turn creating a cycle that continues to repeat itself. The underlying stock’s price escalates rapidly as more cash is spent on call options, making more buying activity and leading to higher stock prices.

A gamma squeeze adds another layer of intensity to a short squeeze because the stock pushes the options until the options push the stock. As the buyers try to both buy stock and buy options, they’re caught in a cycle of back and forth between the two. The stock ultimately keeps climbing until it crashes, and what makes it even more dangerous is that usually, the fall is much faster than the climb.

Is gamma squeezing a good idea?

There’s no doubt about it, gamma squeezing (and day trading in general), is a risky business. A squeeze can last for days, weeks, or hours—and the price can fall drastically without warning. Investors can never be sure of when this will happen, especially with something as unprecedented as GameStop.

If you’re the type of person who has a lot of money to burn, doesn’t break a sweat at a roulette table, or likes to rappel without a harness, gamma squeezing could be for you. If you’re more of a low-to-medium risk person—and would like your bank account to be too—you might want to give gamma squeezing a miss. But if you do take the gamble, don’t say we didn’t warn you!

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