Gamma Squeeze Explained

by fetch_me_a_block

I’ve been asked to post this here after posting originally in a wsb offshoot, excuse any insults I miss in my very very quick edit:

Today I’m going to attempt to keep you fine folks engaged long enough that we might learn something.

What’s a gamma squeeze and why do I care?

First, let’s get some key definitions out of the way.

Delta – the greek that measures the expected rise or fall in the value of the contract based on a $1 move in the underlying asset. E.g. AAPL is trading at 120.02 and the 5/21 130c is currently trading at 3.37 with a delta of 0.32. If AAPL shares go to 121.02, we can expect the contract to be worth 3.69, holding all other factors stable.

Gamma – the greek that measures the rate of the change of delta. It tells us how fast delta is changing.

Market maker – anyone playing both sides of a security, providing liquidity to the market. Most commonly these are brokerage houses whose goal is to stay neutral. You want to buy that 5/21 AAPL 130c? They’ll sell it to you. You want to sell that same contract? They’ll also buy it from you. Part of this “playing both sides” means actively staying neutral which brings us to our next vocabulary word…

Delta Hedging – a neutral options trading strategy based on the greek “delta”. MMs will buy or sell shares over the underlying asset as the delta goes up or down in order to stay neutral on the trade.

Now, tf is a gamma squeeze?

As options contracts expire, they rapidly approach a delta of 1.00 or 0.00 depending on whether or not they’re “in the money”. Given the rapid move in delta, gamma moves with it since it’s the metric that measures its change. Referring back to delta hedging, this means MMs are buying shares to cover the increase delta in ITM options and at the same time selling shares for contracts whose delta is rapidly decreasing.

So how the fuck does this squeeze?

Recent examples would include the first week GME spiked or more recently when TLRY spiked and every call contract expired in the money. This means as delta rapidly approached 1.00 for every contract, gamma on every contract was rising with it (being “squeezed”). This effect was exacerbated and “squeezed harder” by the fact that there were no OTM contracts for which delta was decreasing, meaning MMs were only buying shares to cover their short contracts. This creates a vicious cycle wherein covering delta pushes the share price up which pushes delta up which pushes gamma up.

A rapid increase in price as contracts expire can also lead to this sort of gamma squeeze but to feel the full effects of it the whole option chain should expire ITM.

If you made it this far I hope you learned something. Feel free to rip me apart in the comments, constructive or otherwise.

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.

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