What is Gamma Squeeze?
Gamma Squeeze
A gamma squeeze occurs when a stock's price rises sharply due to the actions of options traders. This happens when market makers buy or sell shares to hedge their positions, amplifying the price movement.
Overview
A gamma squeeze is a phenomenon in the financial markets that arises from the trading of options. When investors buy call options, it can lead to an increase in the underlying stock's price. Market makers, who sell these options, need to hedge their risk by buying shares of the stock. This buying can push the stock price even higher, creating a feedback loop where the rising price leads to more buying of options and, consequently, more buying of the stock. The term 'gamma' refers to the rate of change of delta, which measures how much the price of an option changes in relation to the price of the underlying asset. When the stock price moves significantly, the delta of the options changes, and market makers must adjust their hedges accordingly. This adjustment can cause rapid price movements, known as a squeeze, as they scramble to buy or sell shares to maintain their hedge. A real-world example of a gamma squeeze occurred with GameStop in early 2021. As retail investors bought a large number of call options, the price of GameStop stock soared. Market makers had to buy shares to hedge their positions, which further drove up the price, leading to significant volatility and substantial gains for some investors. This event highlighted the powerful effects of options trading on stock prices and the dynamics of financial markets.