Gamma is one of the most important options Greeks that traders need to understand. It measures how much an option's delta changes when the underlying stock price moves.
A gamma squeeze happens when market makers who sold options are forced to buy the underlying stock to hedge their positions as prices rise.
Several key conditions must align for a gamma squeeze to occur, including high options volume and market makers being short gamma.
Market makers hedge their options positions by maintaining delta-neutral portfolios. When stock prices move, they must buy or sell shares to rebalance their positions. This hedging activity becomes more intense with high gamma exposure, as delta changes rapidly with price movements.
The gamma squeeze mechanism works through a self-reinforcing feedback loop. As stock prices rise, market makers with short gamma positions must buy more shares to hedge their delta exposure. This additional buying pressure pushes prices even higher, requiring more hedging, creating an exponential acceleration in both price and volume.
Let's examine a real-world gamma squeeze scenario. In this case study, XYZ stock started at one hundred dollars with heavy call option activity at the one hundred five dollar strike. As the stock approached this key level, market makers faced increasing gamma exposure, forcing them to buy shares for hedging. This created the classic feedback loop, driving the stock up twenty-five percent in just two hours with volume spiking three hundred percent above normal levels.
Understanding gamma squeezes is crucial for all market participants. While they create opportunities for significant profits, they also pose substantial risks through extreme volatility and potential market instability. Effective risk management strategies including proper position sizing, stop losses, and diversification are essential. Gamma squeezes ultimately serve an important function in price discovery and market efficiency, but traders must respect their power and unpredictability.