Gamma Short Squeeze
There are times when breaking news and trader sentiment drive trading volumes to excessive levels within a brief time span. Market makers are forced to close out positions which lead to spiking of share prices. While high trading volume is generally positive for day traders it can be a problem for market makers. While a market maker will attempt to mitigate market risk by holding his or her positions it may not be possible if the market is too volatile and trading at excessively high volume. Thus prices spike in a gamma short squeeze.
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Has a Gamma Squeeze Ever Happened?
The Gamestop saga included a gamma squeeze. Think of a gamma squeeze as a short squeeze taken to the next level. It was the introduction of call options and the ability to short them that created the gamma squeeze. Stocks put options prices until options push the stock price. There are a limited number of shares of any stock and when someone shorts most of the stock shares market makers get stuck trying to maintain a fluid market. That was part of the Gamestop saga.
Gamma vs Short Squeeze
While short squeezes are created by traders, gamma squeezes include the market maker in the picture. With a gamma squeeze there are erratic price movements at high trading volumes forcing the market maker to exit their trades. The result is a huge price spike. A short squeeze only involves traders who have shorted stocks and are forced to buy at higher prices due to margin calls or simply a choice to cut their losses.
Squeeze vs Gamma Squeeze
A squeeze is when traders who have shorted a stock get caught in a price increase. Their attempt to profit from an expected price decline has turned into a loss as the price goes up. A trade can purchase the stock in question and settle up for a loss or put money into their account to cover a margin call. When the situation is more extreme the market maker may be forced to exit their positions, which generally accelerates the price increase which is what happened with AMC at the same time as the Gamestop gamma squeeze.
What’s a Gamma Squeeze?
This price surge in a stock is due to traders who shorted a stock being caught on the wrong side of a price increase. The situation gets worse when the market maker is forced out of their positions as well. This huge price surge does not result in a permanent price increase for the stock but rather a temporary top followed by the call. Perhaps the most famous surge was in Volkswagen in 2008 when the stock went from €25 to €1,000 and then back again briefly making VW the most valuable company in the world.
Gamma Squeeze Explained
Why does a gamma squeeze happen? It starts with a substantial number of people shorting a stock or a few people shorting large amounts of a stock. This is done because the trader expects to see the stock price fall. They expect to be able to buy shares for a cheaper price to pay back the ones that they borrowed thus pocketing a profit. When the stock unexpectedly goes up the folks who shorted the stock are now losing money. They step in to buy shares to cut their losses thus driving prices even higher. When it gets bad enough the market maker is forced out of his position causing an even greater price increase.
Reverse Gamma Squeeze
A gamma squeeze typically lasts a few hours to a few days at most. The Gamestop squeeze was unique in that it went on for a couple of weeks. However, all gamma squeeze peaks end up reversing. Anyone who tries to buy into a gamma squeeze needs to be very nimble because if they buy in too late they get caught in a reverse gamma squeeze as the price falls back to its usual trading range. Traders sell to cut their losses thus driving the price even lower in a mirror image of the initial squeeze.
Squeeze Metrics Gamma
A gamma squeeze can result in an exceptional rise in stock price. In the case of Gamestop the market cap of the company went up 1000% (tenfold). Although the Gamestop squeeze lasted for weeks the more common scenario is that the stock price peak of a gamma squeeze will last for a few hours at best. The stock price is mostly driven up because those who shorted the stock are forced to buy to get out of their losing positions and the situation gets so extreme that the market maker is forced out of his positions. When this dynamic is finished there is nothing supporting the stock price and traders sell to take their profits as the stock price plummets.
