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GameStop Corp. (NYSE: GME) shares are on a wild ride, rocketing over 1,500% higher in the last month. One of the main reasons behind this incredible story is something called a "gamma squeeze."
Many traders are hearing about it for the first time, so we're doing a deep dive on what it means and why it's pushed the stock so high.
You see, GameStop isn't on a rocket ride because people like the stock this much. While there are plenty of bulls who saw GameStop as a value play a few months ago, it's incredible price jump has taken it out of the realm of normal valuation.
Part of what's propelled its surge came from short selling and call options traders.
The stock was under attack by short sellers, who borrow shares to sell, hoping to buy them back at a lower price when the stock falls. However, the problem was that short interest, or the percentage of the total shares outstanding that have been borrowed to sell short, was over 100%.
Many investors have heard about a "short squeeze" that can force all these short sellers to buy back those shares at any price they can. Their losses can be tremendous, so they are willing to pay up to close their positions, and that extra demand is like rocket fuel for the stock.
GameStop was hit with an epic short squeeze.
But that was the first phase of this trading madness. The next was the real headline grabber.
The "Gamma Squeeze" that Pushed GameStop Higher
Investors started buying far out-of-the money call options, and lots of them. That forced options market makers – the people who directly take the other side of those trades to create an orderly market – to buy shares of GameStop stock to hedge against the calls they had to sell to the initial buyers. The stock price soared.
"Gamma" is one of those options terms – the Greeks – that describe how an option price changes depending on the strike price and time left to expiration. (For more on options trading, check out our complete guide.)
Market makers use "delta" to decide how many shares of a stock they need to buy in order to hedge. Delta measures how much an option price moves for every $1 move in the underlying stock. The closer the stock climbs to the strike price of the call option, the higher the delta and the faster the option price moves.
Gamma is a derivative of delta, and it describes how fast delta changes. As the stock price climbs, so does gamma. And gamma moves faster than delta. Think of the variable X as delta. In that case, gamma is more like X squared. It moves exponentially faster.
This creates a positive feedback loop as the more the stock rises, the more shares market makers need to buy to hedge against the options they sold. This is the "gamma squeeze." As the stock price rises and brokers need to buy more shares to hedge, the stock price is pushed even higher.
The combination of a short squeeze and a gamma squeeze helped launch GameStop from a mere $18 a share a month ago to over $300 a share today.
While GameStop's sudden explosion is a unique event, largely driven by social media, it shows how knowing a bit more about the mechanics of the options market can help set your trades up for success.
Knowing which stocks are under short pressure or how the Greeks are behaving can help expert traders spot opportunities the rest of the crowd is missing.
That's why our experts are constantly scouring the data and passing along the findings right to you.
Check out one strategy Andrew Keene is using to spot opportunities in the options market right now…
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