What is a Gamma Squeeze? Understand the GameStop Play

Core Concept - A gamma squeeze is a phenomenon in the options market where a stock experiences a rapid price increase due to market maker hedging in response to heavy call buying [2][11]. Options Market Overview - Options are financial derivatives that give the owner the right to buy (call options) or sell (put options) an underlying asset at a specified price before expiration [3]. - Options pricing is influenced by various factors, including the underlying asset's price movements, and is more complex than equity pricing [4]. Options Greeks - Delta measures the change in an option's price with a $1 move in the stock, while gamma measures the rate of change in delta for every $1 move in the stock [5][6]. Anatomy of a Gamma Squeeze - A gamma squeeze typically involves four key components: 1. Flurry of Call Buying: Significant out-of-the-money call options are purchased, often driven by speculative retail investors [7]. 2. Hedging Market Makers: Market makers, primarily Wall Street firms, hedge their positions by buying underlying shares when they sell call options, especially when 0DTE options are popular [8]. 3. Price Momentum and Feedback Loop: The stock price rises due to market maker purchases, leading to increased delta and further stock purchases to manage risk, creating a feedback loop [9]. GameStop Example - The GameStop (GME) case exemplifies a gamma squeeze, where retail investors and short sellers contributed to extreme price movements, exacerbated by the COVID-19 pandemic and the rise of commission-free trading [9]. Risks of Gamma Squeezes - Gamma squeezes are characterized by hyper volatility, lack of control for traders, and unsustainability, often leading to significant losses for latecomers [10].