Understanding Gamma Squeeze in the Stock Market
In the world of trading, certain market moves can happen with such speed and intensity that they catch even seasoned investors off guard. One such phenomenon is the Gamma Squeeze — a technical event that can send stock prices soaring in a short period, often driven by complex dynamics in the options market. To understand a gamma squeeze, it’s essential to first grasp the role of options, market makers, and a concept called “gamma.”
What Is Gamma?
In options trading, “gamma” measures the rate of change in an option’s delta, which itself measures how much an option’s price will move with a $1 change in the underlying stock. For example, if a call option has a delta of 0.5, it will gain 50 cents for every $1 increase in the stock price. Gamma tells you how much that delta will change as the stock price changes.
Gamma is highest for at-the-money options (where the strike price is close to the current stock price) and increases as the option approaches expiration. This detail is crucial in understanding the mechanics of a gamma squeeze.
The Role of Market Makers
Market makers are firms or individuals who provide liquidity in the options market by standing ready to buy and sell options. When retail or institutional traders buy a large volume of call options on a stock, market makers often take the opposite side of those trades. However, this creates risk for the market maker if the stock moves sharply.
To hedge their exposure, market makers will often buy shares of the underlying stock. This practice is called delta hedging. The more the stock rises, the more shares the market makers must buy to stay hedged. And as the stock price approaches the strike prices of the options they’ve written, gamma increases — forcing market makers to buy even more stock at an accelerating rate. This buying activity can create a feedback loop.
How a Gamma Squeeze Unfolds
A gamma squeeze begins when traders (often retail traders on platforms like Reddit or Twitter) purchase large volumes of call options, particularly near-the-money or out-of-the-money options. This pressures market makers to buy the underlying stock in increasing quantities as its price rises.
This new demand for the stock from market makers adds upward momentum to the stock’s price, which can attract more traders and media attention. If the buying frenzy continues, it creates a self-reinforcing cycle of rising prices and more hedging activity.
This is what happened during the infamous GameStop (GME) rally in early 2021. A group of retail traders coordinated to buy large amounts of call options, which in turn forced market makers to buy millions of shares to hedge their positions. This buying pressure caused a dramatic surge in the stock price — a textbook gamma squeeze.
Gamma Squeeze vs. Short Squeeze
While similar in outcome, a gamma squeeze is not the same as a short squeeze. In a short squeeze, traders who have bet against the stock by shorting it are forced to buy shares to cover their losses as the price rises. In a gamma squeeze, it’s the option market hedging — not short covering — that fuels the rally.
That said, both phenomena can happen at the same time, intensifying the price spike. GameStop is again a prime example, where both a gamma and short squeeze played out in tandem.
Risks and Final Thoughts
Gamma squeezes are speculative, fast-moving, and often driven by emotion and technical factors rather than fundamentals. While they can lead to enormous gains in a short period, they are also highly risky. Prices that go up quickly due to a gamma squeeze can crash just as fast when the momentum fades or when market makers finish hedging.
For retail investors, understanding the mechanics of a gamma squeeze is important — not necessarily to chase the next one, but to recognize when one might be happening and make informed decisions accordingly.