Crypto

Basic options theory and how it works -by Ecork

Gamma Squeeze Speaking Points

Some find gamma pressure to be an ambiguous concept. This article aims to shed light on the intricacies of gamma pressure by covering the following main ideas:

  • What is gamma pressure?
  • The Greek delta and gamma calling table.
  • What causes gamma compression and how can you avoid it?
  • Gamma pressure vs. short pressure.
  • An example of gamma pressure.

What is gamma pressure?

Gamma pressure is a function that market makers perform to hedge their exposure to negative gamma (short) and negative delta (short) risks after selling a call and options on a specific stock.

This may all seem confusing, so let’s break it down:

Delta – This represents the expected change in option price In response to changing $1 in Basic share price. Positive deltas indicate a long position in the market because the price of the option will rise in line with the rising price of the stock (delta), while negative deltas relate to the market being short.

Gamma – Gamma is the first derivative of delta and simply refers to Delta change rate. Gamma values ​​are highest for ATM (at the money) options and lowest for OTM (out of the money) or ATM (at the money) options.

long gamma Indicates that the delta of the option position will rise when the stock price rises and vice versa.

sHurt Gama – Indicates that the delta of the option position will decrease when the stock price rises and vice versa.

The above chart shows how the contact delta values ​​change with stock prices. The slope is steeper around the ATM options which is the rate of change and therefore the gamma itself. The flat curve for deep OTM options graphically shows why the gamma is low for deep OTM and ITM options.

Greek delta and gamma calling table

direction

delta

gamma

long call

+

+

short call

What causes gamma compression and how can you avoid it?

There is no single factor that contributes to gamma pressure, however, there are several important donors to this phenomenon:

  • Short term call options on stocks.
  • Delta hedge.
  • Low liquidity stocks.

To avoid the negative effects of gamma pressure, investors should keep in mind two simple rules:

  • Do not sell stocks during gamma pressure – try to pick peaks.
  • Stay away from selling call options.

Gamma pressure vs. short pressure

Short pressure involves shorting or borrowing shares and repurchasing at a later date but when buyers flood the market and push the stock price higher, short sellers add upward pressure by joining in the buying frenzy in an effort to mitigate losses and close their positions.

On the other hand, gamma pressure includes options, and when market makers sell deep OTM options, they are required to buy more and more shares to hedge their exposure to rising stock prices with higher gamma of the option, hence it is called “gamma pressure”. This may be more clear with the example below.

Example of gamma pressure

Recently, the GameStop (GME) scene made headlines after the rapid rise in its share price inside Relatively short period of time (see chart below). When investors buy call options in GME, there must be a counterparty. In most cases, the market maker (the counterparty) takes this position on the other side of the trade. Market makers are generally indifferent to the price movements of the underlying stock and the profits from the trade itself (the spread). Therefore, placing additional buy calls carries risks for the market maker in the event that the price of the underlying stock increases. To hedge against such opposite moves, the market makers go to the market and buy the stake in question.

This is the reason in the end for the sharp increase in the share price of GME. In theory, this event was a combination of short and gamma pressure with gamma pressure providing additional fuel for the fire.

GameStop Corp. vs. S&P 500 Index

GameStop gamma squeeze vs SPX

The graph was prepared by Warren VenkitasRefinitiv

Connect with Warren and follow her on Twitter: Tweet embed

Related Articles

Leave a Reply

Your email address will not be published.

Back to top button