Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
A gamma squeeze is a rapid stock price surge triggered by options hedging activity. Heavy call buying can force market makers to buy shares, which may push prices higher.
In general, a squeeze describes a situation where investors are pressured to make a move that they otherwise would not have made. In a short squeeze, short sellers are forced to buy shares to cover their short positions when prices rise, which can further drive up the price of the shares. In contrast, a gamma squeeze involves call option activity that triggers market makers to hedge their position, which can drive prices up. This feedback loop is distinct from short sellers covering losses.
This article digs into what a gamma squeeze is, what it has to do with options trading, and what it means for investors.
Overview of Options Trading
Here’s a quick recap of how options trading works. Options can be bought and sold, just like stocks. In short, they’re contracts that give purchasers the right (but not the obligation) to buy or sell an asset — i.e., the option to transact.
Options can be used to speculate on price changes. For example, if an options trader thinks the price of a stock is going to increase, they can purchase an options contract to put themselves in a position to profit if their prediction were to come true.
There are two basic types of options: call and put options. A call gives purchasers the right to buy an asset at a certain time or price, whereas a put gives them the right to sell it. Buying these types of options allows them to effectively bet on a stock, without outright owning it. Purchasers typically pay a “premium,” or the price of the contract.
Generally, if an investor thinks a stock’s price will increase, they buy calls. If they think it will decrease, they buy puts.
Recommended: Options Trading Terminology
Gamma Squeeze Definition
A gamma squeeze has to do with buying call options. Remember, purchasers buy calls when they think the price of a stock is going to increase. And as the price of that stock increases, so does the value of the call option. Now, when a stock’s price starts to increase, that can lead to more investors buying calls.
But on the other side of those calls are the traders or institutions that sold them — remember that options are a contract between two parties, so for an investor betting on a stock price’s increase, there’s another that’s betting that it’ll fall. They’re taking a “short” position, in other words.
“Market makers” — trading firms that sell call options — are typically the party on the other side of the trade. They’re essentially “short” those call options that investors in the market are buying. These market makers face a good amount of risk if the price of the underlying stock rises, so they typically will buy some shares of the stock to hedge some of that risk, which can help balance their overall exposure.Buying the shares also helps to ensure that they will be able to deliver the stock if they become “due,” or the investor exercises their call options.
However, if investors keep buying more and more calls, and the stock’s price increases, market makers need to buy more and more stock — increasing its price even further, and thus, creating a “squeeze.” The gains in share value increase market makers’ risk exposure, prompting additional hedging.
Part of this is also because the stock’s gains bring the options closer to the prices at which calls can be exercised.
Basically, the short positions held by some investors may allow a gamma squeeze to happen. And if a stock’s price rises instead of falls, the shorters’ need to start buying the stock, further increasing its price, creating the feedback loop mentioned earlier.
Recommended: Shorting a Stock Explained
What’s Gamma in Options?
Okay, so you may have a grasp on how a gamma squeeze can occur. But we still need to talk about what gamma is, and how it fits into the picture.
Gamma is actually just one of a handful of Greek letters (gamma, delta, theta, and vega) that options traders use to refer to their positions. In a nutshell, the Greeks help traders determine if they’re in a good position or not.
For now, we’ll just focus on delta and gamma. Gamma is actually determined by delta. Delta measures the change of an option’s price relative to the change in the underlying stock’s price. For instance, a delta of 0.3 would mean that the option’s price would go up $0.30 for every $1 increase in the underlying stock’s price.
Gamma measures the rate at which delta changes based on a stock price’s change. It’s sort of a delta of deltas. In other words, gamma can tell you how much an option’s delta will change when the underlying stock’s price changes. Another way to think of it: If an option is a car, its delta is its speed. Gamma, then, is its rate of acceleration.
When a gamma squeeze occurs, delta and gamma on options fluctuate, which may contribute to stock volatility and pressure certain market participants.
The Takeaway
When investors are making bullish bets on a stock, sometimes they use call options — contracts that allow them to buy a stock at a certain date in the future.
When brokers or market makers sell those call options to the investors, they buy shares of the underlying stock itself in order to try to offset the risk they’re exposing themselves to. This also helps them ensure they can deliver the shares if the options get exercised by the investor holding the call options.
Gamma squeezes may occur when market makers rapidly buy shares, contributing to a sudden increase in stock prices.
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With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.
FAQ
What happens during a gamma squeeze?
During a gamma squeeze, rapid buying of call options leads market makers to hedge their risk by buying the underlying stock. This buying activity can push the stock price higher, which may trigger further call option activity. This may create a feedback loop that drives additional volatility, accelerating a rise in price.
How long does a gamma squeeze last?
There is no set timeframe. A gamma squeeze can unfold over hours or days, depending on factors such as investor sentiment, trading volume, and how quickly market makers adjust their hedging strategies. They often end once demand for options eases or the stock stabilizes.
Is a gamma squeeze good?
It depends. For some investors, a gamma squeeze may present short-term opportunities if they’re positioned correctly. Volatility can also expose traders to significant risk, especially if prices move sharply in either direction without warning.
Has a gamma squeeze ever happened?
Yes. Several gamma squeezes have occurred, often tied to stocks with heavy options trading and high short interest. In certain cases, option activity has prompted market makers to rapidly buy shares to manage risk, which contributed to sharp price increases.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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