How a Gamma Squeeze Works

When actively trading in the market, serious traders love to see a solid short squeeze to trade. But, have you ever wondered if there are other squeezes that traders can look for in the market? And the answer to that question is yes, and it’s known as a gamma squeeze. A gamma squeeze is a sudden rapid, significant price movement in a stock that resembles a short squeeze but occurs under different conditions.

The conditions that form a gamma squeeze are when traders start a series of weekly out-of-the-money (OTM) call buying within the options market. When stocks are undergoing a massive amount of traders buying OTM options, that type of activity will create a rare series of events that will quickly increase the stock price. So, let’s dive into the mechanics of a gamma squeeze and how to spot one.

What is a Gamma Squeeze?

What is the gamma squeeze meaning? In options trading, there is always a buyer and a seller. But, when it comes to a gamma squeeze, certain types of options get bought. For example, a trader buys a call option in XYZ. The dealer who sold you the call is now short delta in the stock, but dealers are required to be Delta Neutral, so they must buy XYZ stock to cover the sold options. The gamma squeeze takes things much further than an ordinary OTM call buying process; it occurs on a massive scale. 

Either an individual or many individuals have purchased OTM calls, forcing the dealer to buy as many shares of the OTM calls they have sold. The volume of calls and regular stock buying creates rising prices and gamma exposure within that stock. For the dealer, it creates a frenzy of stock buying because of OTM call buying. For instance, the option buyer may have started buying calls at Delta 30. But because of the influx of mass buying, the stock is more expensive, and now the call costs Delta 50. The dealer has to buy more stock to stay Delta Neutral. 

The gamma squeeze creates a brutal cycle for the dealer that they are unable to stop: 

• OTM Call buying
• Stock hedging 
• Stock rising 
• More OTM call buying
• More stock hedging at a higher stock price

The dealer’s gamma and delta are dangerously exposed when caught in this type of predicament within the market. The dealer snowballs into losing more and more money after each transaction has occurred. 

Video Guide of a Gamma Squeeze

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Gamma Squeeze vs. Short Squeeze 

A gamma squeeze will look like a short squeeze to the average trader, but there are differences that traders need to understand. A short squeeze is a vertical increase in price because traders are shorting a particular stock chasing it higher. 

A gamma squeeze is a vertical increase due to traders buying OTM call options, which forces dealers to buy that stock. Typically, traders can identify a gamma squeeze by massive weekly call volumes on OTM strikes.   

What OTM calls buying looks like:

• If Tesla (TSLA) is selling call options at $900, then the buyers would buy at $1000
• If Apple (AAPL) is selling call options at $150, then the buyers would buy at $160  

The buyers buy OTM call options on a massive scale, creating a momentum ignition. When sophisticated traders start to see a gamma squeeze with a particular position, traders jump on the opportunity and try to ride the wave. Dealers are essentially powerless in the case of a gamma squeeze; unfortunately, the dealers have to keep buying the stocks as more and more OTM calls are being purchased.

Example

The gamma squeeze is a rare phenomenon; it’s not a regular occurrence within the market. It’s usually a carefully calculated act involving a very wealthy individual or a massive community of motivated traders who are all on the same page. Rarely do gamma squeezes happen on accident under normal operating circumstances. However, it’s an extraordinary event that creates headlines and controversy when they happen. Two stocks in recent history have achieved successful results that will go down as the greatest gamma squeezes in history.

GameStop (GME)

GameStop once reigned supreme as the nation’s top video game retailer. But because of technological advancements and changes in consumer spending, GameStop was soon overtaken by its online competitors. Consumers can now buy video games with their preferred game system and get the games they desire, easier, faster, and cheaper.

Unfortunately for GameStop, their business model was outdated. For years, their stock steadily declined, making them vulnerable to being shorted by traders and investors who could easily predict the stock would fall. Shorting GameStop was a safe bet, and many traders saw it as easy money, but 2021 happened.

AMC (AMC Stock)

AMC is another company that has been negatively affected by technology and consumer spending changes. However, AMC was also heavily impacted by a worldwide pandemic that caused financial hardship, which was already struggling under normal circumstances. Like GameStop, AMC fell victim to traders who relentlessly shorted the stock because of their outdated business model. Traders who enjoyed gains from shorting AMC found their day of reckoning by the Reddit community in 2021.

In the chart above, the AMC stock rose to uncharted gains within the stock market that the company has ever experienced. But, like GameStop, AMC was going through a gamma squeeze due to the Reddit community buying many OTM calls. Those OTM calls forced the dealer to buy AMC stock at an alarming rate that got considerably more expensive. However, just like GameStop, this situation was short-lived. While a gamma squeeze is ongoing, trading is risky, and one should be cautious about getting into the action.

Gamma squeezes are not a regular part of trading. They happen so infrequently that it would be better if traders stick with their trading plans. However, if you have stumbled upon an opportunity, be sure that you recognize it correctly and not mistake it for being a short squeeze. The most significant separation between the two is that short squeezes often occur, while gamma squeezes have a more mechanical operation that is needed to work.

The market is a risky and unpredictable entity, and such setups can hurt traders’ portfolios if they are on the wrong side of the trade. However, our traders provide actionable insights daily in the Simpler Options Gold room. Join the Simpler Trading Options Trading room, where you’ll find live traders, the best technical analysis, and live trade alerts. Learn from their expertise, immerse yourself in a supportive community, and watch your trading skills soar to new heights!

FAQs on the Gamma Squeeze