A gamma squeeze is a market phenomenon where rapid price appreciation of an underlying asset forces options market makers to buy more of that asset to hedge their short gamma positions. As the asset price rises, the delta of their long call options (or short put options) increases, requiring them to purchase more of the underlying to remain delta-neutral. This buying pressure further pushes up the asset price, creating a self-reinforcing cycle. It often occurs with significant options volume.
Mechanism
The mechanism begins when a large number of market participants buy call options, often out-of-the-money, on an underlying asset. As the asset price approaches the strike, market makers who are short these calls experience an increasing positive gamma. To hedge their exposure, they must buy the underlying asset as its price increases. This demand can become substantial, particularly in illiquid or highly volatile markets like cryptocurrency. The feedback loop intensifies price momentum.
Implication
Gamma squeezes can lead to extreme, rapid price movements in the underlying cryptocurrency, often detached from fundamental value. For options traders, understanding the gamma exposure of market makers can inform strategic positioning, though timing is challenging. Risk managers must account for the potential for such non-linear price dynamics, as they can trigger significant margin calls and liquidations across the derivatives ecosystem. The impact on volatility can be profound.
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