Introducing the Gamma Squeeze

Short sellers of GameStop, AMC, BlackBerry, Express and others just met Gamma the hard way.

Before this week, only financial quants had ever heard of "Gamma".  For those of us who model options strategies around volatility, the series of Greek letters describing financial pricing attributes are a thing of beauty.

To be technically precise, "Gamma" describes the rate of change of "Delta".  In options land, "Delta" is the rate of change in an option price for a given price change in the underlying security. 

In a practical sense, a broker dealer may have a client that wants to buy a cheap out of the money call option.  A short-term option with a 150 strike on a 100 stock would be fairly cheap, hence attractive to retail investors who read on a chat board that the price is about to double.  The investor would profit handsomely if the stock rose to say $200.

On the flip side, the BD would facilitate by taking the other side of the trade and short the option.  But the BD would hedge its short position by buying a small amount of the underlying stock.  Gamma, in conjunction with Delta, is the measure we use to determine the hedge ratio.  Since the stock is well out of the money, the Gamma and Delta would be fairly low, and the BD may only need to buy 10 or 25 shares to "perfectly hedge" 100 short options.

However, sometimes the stock actually does go up.  That happened this week as the shorts were squeezed in GME, AMC, BB and others.  As the stock price approaches the strike price of the option, its Gamma and Delta rise.  The BD needs to buy more shares to maintain the proper hedge ratio.  (Think of gearing) Of course, that buying further increases the stock price.  

Now looks at what happens when Gamma squeeze meets Short squeeze.  Round and round they go.

Just look at this action for the two weeks between Jan 13 and Jan 27, 2021 as I write this:

• GameStop rose from  $20 to $347
• AMC Entertainment rose from $2.20 to $19.88
• BlackBerry rose from $7.50 to $25.00
• Express (the Limited spinoff) rose from $1.02 to $9.55

We'll return to this topic later to see how the movie ends.

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