What is a Gamma Squeeze? It’s basically short selling on steroids. When you’re shorting a stock, you believe the price of the stock is going down. So you sell a stock without owning shares, to cover when it reaches its bottom or support. When you’re adding Gamma in there, you’re referring to the option trades on that stock. Because BANG stocks have become so popular, a lot of folks are wondering, will $AMC gamma squeeze? or $GME for that matter?
What Is a Squeeze in Investing?
Before diving into the specifics of a short squeeze and a gamma squeeze, let’s first discuss what a squeeze means when it comes to investing in stocks.
You may have heard the term being thrown around after the recent squeeze of stocks like GameStop (NYSE: $GME) and AMC (NYSE: $AMC).
This was done by members of the Reddit group r/WallStreetBets. Despite the mainstream spotlight, short squeezes don’t actually happen as often as these events may have you believe.
A squeeze of any type refers to a fundamental change in the behavior of an underlying stock or the market in general, that causes investors to buy or sell shares of the stock to protect their original position.
The result is usually an accelerated shift in the price of the stock due to abnormal buying or selling of shares to either hedge or buy out of a position that is no longer profitable.
Options are a great way to make money without having a large account. You just need to know how they work. Options aren’t as cut and dry as stocks. But they give you the option to own shares at a cheaper price. Or the right but not the obligation to own the shares.
Which is a lot different than owning shares outright, right away. It’s the things like Gamma that can get you, however. Especially if you don’t know what goes into an options contract.
Short Squeeze vs. Gamma Squeeze
A short squeeze is specific to a scenario when there are investors (usually hedge funds or institutional investors) that own a short position in a particular stock. A short position means the investor believes that the overall trajectory of the stock or company is down. Therefore, they’re intending to capture that downside by buying a put option.
A put option allows investors to buy the shares at a strike price below the market price. Then sell those shares for a profit. In a short squeeze, the price of the equity rises rapidly. Therefore, forcing short sellers to cover their short positions by buying actual shares of the stock to capture the rising price as a hedge.
What Is a Gamma Squeeze Explained
A short squeeze forces short sellers to buy up shares as the stock price rises. A gamma squeeze actually takes this one step further. If you thought that a gamma squeeze was just a cool-sounding name for a really powerful short squeeze, you’re actually not too far off. There’s a little bit more nuance to it. But in layman’s terms, a gamma squeeze is essentially a turbo-charged short squeeze. Let’s take a look at how this perfect storm of events takes place.
When you hear the term gamma, that should be your first clue that a gamma squeeze has something to do with options trading. Gamma is one of the essential indicators known as ‘the Greeks’ that options traders use to determine the volatility and risk associated with purchasing a specific options contract.
Gamma calculates the rate of change for the price of the option’s delta. For every move by 1-point in the actual price of the underlying asset. The delta is another Greek indicator that calculates the ratio between a change in the price of the asset to a change in the price of the option.
So because the risk and volatility of both the underlying asset and the option are the lowest when both are at the money, gamma is calculated as 1 at the price. It gets smaller as it moves in either direction.
That’s a little hard to wrap your head around if you aren’t an experienced options trader. Here is a visual look at how gamma and delta affect the options price for a $50 stock.
What Triggers a Gamma Squeeze?
So a gamma squeeze begins with a stock that has large short positions as AMC and GameStop did. Then a tide of investors believes the price of the stock will actually rise. Which is contrary to the existing short positions. But instead of just buying shares, the bullish investors also need to buy short-dated call options on the stock. This puts pressure on the short positions, as the call/put ratio becomes increasingly inflated.
So now you can see why a gamma squeeze causes such a rapid rise in the price of the underlying stock. Investors with the call options can make a massive profit off of a small initial investment on the call options. And institutional investors who hold short positions, have to continuously buy up shares to cover their initial positions. When there aren’t any more shares for them to buy, we see hedge funds having to close out their positions by taking large losses on their short positions.
The GameStop and AMC Squeezes
Back in January of 2021, the first coordinated meme stock squeeze took place. Members of the subreddit r/WallStreetBets began formulating a plan to cause a gamma squeeze in GameStop and AMC.
Both had significant short positions at the time. Keep in mind that this particular event was a little different from other squeezes as it really doesn’t have anything to do with the future success of the underlying companies.
When members of WallStreetBets began to organize the squeeze, GameStop had a staggering 140% of its total number of shares in short positions. The result?
As you can imagine, once both retail and institutional investors began to buy up shares of GameStop, the price skyrocketed. It hit $500 per share by January 28th in pre-market trading.
Just a few weeks earlier, shares of GameStop were trading at just over $17 per share. You can see how quickly gamma squeezes can affect the price of the underlying asset.
The most famous case of the GameStop and AMC short squeeze? Redditor Keith Gill, also known as Roaring Kitty on Twitter or DeepF*ckingValue on Reddit, famously purchased $53,000 in call options for GameStop way back in 2019. Be believed the stock to be tremendously undervalued.
At the height of the squeeze, Gill’s position was worth $48 million. But he exhibited diamond hands and held through the rise and subsequent fall of GameStop’s stock price. Finally, in April of 2021, when the call options were set to expire, Gill exercised all of them, giving him a position in GameStop of 200,000 shares that were valued at more than $30 million.
What Happens if AMC Squeezes?
Recently in May of 2021, there was another organized gamma squeeze. And this time AMC was the focus. In the span of a few weeks, shares of AMC surged by nearly 700%. Shares hit an all-time high price of $72.62. This included a single day gain of 102% on May 26th. As a result, this added an unimaginable $16 billion to AMC’s market cap during one trading session. The catalysts were very much the same as the GameStop squeeze from January. And short sellers have reportedly lost well over $5 billion during the past few weeks.
AMC has been struggling to keep afloat as the COVID-19 pandemic shut down customer flow to the theaters for the better part of a year. The company owns well over 1,000 theaters both domestically and internationally. And thanks to the squeeze have managed to fend off bankruptcy for the time being. CEO Adam Aron has reached out to AMC shareholders and has offered free popcorn as a reward. That doesn’t seem like much consolation for saving the company from bankruptcy and exponentially growing its market cap.
What Happens After a Gamma Squeeze?
Well, to put it lightly, there isn’t really anywhere for the price of the stock to go but down. We saw it happen already in January when GameStop and AMC saw its share price cut in half following the height of the squeeze. More recently, after AMC hit its highs it also fell 30% the next day. Once the momentum of the gamma squeeze stops, the downside is often much faster than the squeeze itself.
This is one of the fundamental problems with these coordinated social media squeezes. Retail investors believe that only institutional investors lose. But there are also millions of retail investors that were left holding $400 shares of GameStop after getting in too late. FOMO, or the Fear Of Missing Out, is a very real emotion for novice investors. And chasing other investors’ gains is a sure way to end up holding the bag at the end of the day.
The Bottom Line
They may be tempting as a way to get rich quickly. Certainly, some traders can get rich by following these trends. If you ask us, it’s a little too much volatility to get involved in these Reddit gamma squeezes. Not to mention borderline illegal. There’s a reason why the trading platform Robinhood had a congressional hearing following the event in January. The two worlds of social media and investing have caused an entire generation of traders to gamble away money by chasing these gains.
There’s nothing wrong with researching a company and analyzing the share ownership. If it contradicts what you believe, then starting a position does increase the likelihood of a short or even gamma squeeze happening. Just look at Tesla (NASDAQ: $TSLA) as a more realistic example of how a stock price can squeeze based more on the fundamentals and future performance of the company. Let’s just say that the GameStop and AMC gamma squeezes should be considered the exceptions and not the rule.