What Is A Gamma Squeeze? A ton of investing terms exist that you might not be familiar with. A “squeeze” is one of those. Whenever a company experiences hasty changes to its stock price, it creates the perfect environment for a squeeze.
A squeeze in investing terms means that the investors of that stock are “squeezed” into an unfamiliar position. This is usually due to a high buying demand for that stock. The investors that shorted the stock are now rushing to exit their position. As one can imagine, this drives the price to go even higher.
There are two types of squeezes in the investing world – a short squeeze and a gamma squeeze. The stock market is a great place for amateur traders to make money. So understanding how a gamma and a short squeeze works are important. Let’s explain both.
What Is a Short Squeeze?
A short squeeze can be very good for the person shorting the stock or go terribly wrong. A clear example of this going terribly wrong is the recent phenomenon around GameStop. In that particular example, investors decided to short the price of GameStop – bet on the price going down. Investors didn’t feel the company justified the stock price, so they bet billions on the price going down.
This went very well for the investors at the beginning, but things would swiftly change for the worse. Namely, this is all thanks to a subreddit called Wallstreetbets. The amateur investors over at Wallstbets found out that big money players had shorted GME stocks. Shorting a stock price isn’t usually a problem. It becomes a problem when the price doesn’t go down, and especially if the price hits an all-time high of $483!
Traders from Wallstbets were very bullish on GME and they bought the shorted stock. This forced investors that shorted GME to buy back the shares at a higher price. This cycle went on for weeks – a cycle where investors kept losing money due to short squeezing.
What Is A Gamma Squeeze?
A gamma squeeze is different from a short squeeze. As we mentioned before, a gamma squeeze is when the price of a particular stock rapidly changes. This trading event happens over a short period of time. But unlike short squeezing, traders purchase options. Traders get in a contract with market makers, where the market makers buy shares depending on the Delta of the contract.
In stock options, a Delta is a ratio. You will also find it under a different name – hedge ratio. This ratio represents the number of shares that the market maker has to hedge to cover a short. Again, much like in short squeezing, the delta isn’t a problem when the market maker sells a contract for a couple of thousand shares.
When Is the Delta A Problem?
The Delta becomes a big problem when traders buy hundreds of thousands of shares. Since traders buy more shares, the price goes up. So the market maker has to constantly hedge by buying more shares. When this repeats over and over again, it creates a gamma squeeze. Gamma squeezes are bad news for market makers. That’s because the price of the shorted stock continues to rise, subverting expectations.
Since market makers are only interested in making money, a gamma squeeze is something they don’t want. Every trader should know what a short and gamma squeeze is. But that’s not everything a trader should know. Before a trade even starts trading, it’s important to know these 5 stock trading tips.
When Does A Gamma Squeeze Occur?
One thing we have to mention is that, although short and gamma squeezes are different, a gamma squeeze occurs after a short squeeze. So a gamma squeeze also occurred in the before-mentioned GME example. The sheer frenzy of GME buying stocks resulted in a 2,500% price increase in only a few weeks. This is the main catalyst for the GME gamma squeeze – traders wanting more stock and call options.
The GME Gamma Squeeze
There’s a reason why GME is a once-in-a-lifetime example of the worst gamma squeeze. In the case of GME, investors underestimated their opposition. Since investors shorted the price of GME, they could have protected themselves by buying a call option. But they didn’t do that. So before we get to the GME gamma squeeze, we have to mention that the short squeeze has been happening for well over three months.
In that time, investors shorted the stock and bought out-of-the-money call options. Traders, on the other hand, took full advantage of the short squeeze and bet on the price going higher. What all of this does is make the price of GME go up instead of down.
This is bad news for hedge funds and investors who put billions on the line. A return on investment doesn’t look like it’s going to happen. But what is going to happen is a gamma squeeze. As more investors are buying shares to cover the delta, the price as a result of the subsequent purchasing of shares by investors is going up.
How Long Does A Gamma Squeeze Last?
Both gamma and a short squeeze happen at the same time. So does that mean they last the same? The answer depends on what drives the “squeeze”. In the case of GME and AMC, what drove traders was to get one up on the investors and market makers who were betting against both companies. Their prediction was to effectively drive the stocks of both companies to the ground.
So by that logic, the gamma squeeze and short squeeze can last for months. But not every gamma squeeze is the same. Most last only a couple of days with the objective of making short-term profits. As with anything in investing, it’s all about following the trend. And the GME and AMC trend lasted for months.
But since the definition of a squeeze means a rapid change in prices, timing is everything for the trader when it comes to making profits. Even if GME did hit an all-time high of $480, the current price of one GME share is $172. This is still huge if we consider that the price of a single GME share before the shorting was $17.25.
How To Make A Gamma Squeeze Work For You?
Price reversals aren’t uncommon when a gamma squeeze occurs. As a matter of fact, this is the likeliest outcome if you don’t hit the right timing. So, let’s see how to make a gamma squeeze work for you.
- Hit the Right Timing
Timing is everything in investing. During a gamma squeeze, there will come a point where the squeeze reaches its peak. This is when the likely price reversal happens. If you’re not careful, you can very easily lose all the profits made.
- Know When To Get Out and Get In
Another way to make a gamma squeeze work for you is to know when to get out. But there is an even better way to make profits. Namely, every options trader knows that to make the most money out of a gamma squeeze, it’s important to get in before the squeeze happens. But why is that? Once a gamma squeeze occurs, volatility is very high. A volatile market is a riskier market. While you can make tons of money when volatility spikes, there is an equal chance to lose everything.
When on the subject of volatility, the price of a stock can be affected by it. There are two types of volatility in trading – implied and realized. Understanding them can help you figure out how volatility dictates the price of stocks and securities.
What we know about a gamma squeeze is that it is closely related to a short squeeze. While not in every case, a gamma squeeze can mean bad news for investors and good news for traders. In most cases, a gamma squeeze presents an opportunity for investors to make profits by carefully investing. Since the price of a stock surges during a gamma squeeze, knowing when to get out is essential to making profits.
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