Gamma Squeeze

The concept of short Squeeze is prevalent in market these days but the correct terminology to define this concept is Gamma Squeeze.

Before describing the events of Gamma Squeeze, we need to emphasize on the real meaning of Gamma Squeeze.

“Gamma Squeeze” as the term suggests is an outcome where investors using many options drive up the prices of selected stocks due to option sellers who are hedging their trades on the underlying stocks.

Further before going through more on Gamma Squeeze, we also need to understand about Delta.

Delta in case of Gamma squeeze means the quantification of the rate of change of option price in proportionate to the change in the underlying stock price.

For eg: A delta of Re 0.50 means the option price will increase by 50 paisa for every Rs 1 invested in the stock. Delta is basically a non-linear function i.e it will not change proportionately with the price of stock.

Gamma is considered as a first derivative of delta and it is used when we try to measure the price movement of an option. Practically, it is relative to the amount it is “In to the money or out of the money” The following chart shows what an options delta chart would look like for a long call option on a stock. A long call option gives its holder the right to buy “X” number of shares of stock at a given strike price, while the seller of the option will hold the reciprocal obligation to sell those shares at the exercise price. If we consider the following chart, it is clearly visible that the option delta is a nearly flat line around zero when a stock’s price is well below the option’s exercise price. Further, it is also a nearly flat line around 1 when that stock’s price is well above the option’s exercise price.

If we see the middle portion of this chart, delta chart curves upward, reaching a value of 0.5 and further reaching its steepest slope at exactly the option’s strike price. It’s the slope of the option’s delta chart that represents the option’s gamma, and that slope and thus the gamma is at its steepest at exactly that option’s exercise price.

For Additional reading:

How negative Gamma is currently impacting the price action in QQQ.

https://themarketear.com/posts/cc25XMOveX/amp?__twitter_impression=true

Gamma Squeeze is nothing but it is just the latest innovations in centuries of Market manipulation. Given this activity is considered as biggest source for significant volatility and instability, it is worth exploring that how this concept has happened in the past and how it has continued till date:

The Famous Hunt Brothers Silver Squeeze

It was rightly said by Nelson Bunker Hunt that “Almost anything is better than paper money. Any fool can run a printing press.”

Before justifying the words of Nelson Bunker Hunt, we need to review the charts of Silver during the period of 1978 to 1982. The great Burj Khalifa describes it all.

Seed of Silver Boom

After the death of oil tycoon H.L. Hunt in 1974, he left his family billions. His two sons, Herbert and Nelson, took their oil money inheritance into the commodities market. The Hunt brothers always believed that inflation would result in silver becoming a haven, just like gold. 

Nelson “Bunker” Hunt particularly believed there would be high probability chances of inflationary pressures that would destroy the value of any investments denominated in or tied to paper currency.

Physical Demand

Bunker Hunt believed that Silver will have at least a tenfold increase in the price of silver as a result of depreciation of real value of the dollar, so he and his brother began to accumulate physical silver along with entering into large number of future contracts. Instead of closing cash settlements contract (common procedure on the commodities market) the Hunt brother’s took delivery on silver. They piled up the stock of silver in bulk and used their large cash reserves to buy up even more futures.

The billions of dollars inherited from their father was all invested in Silver which triggered the rise of silver to more than $50 per ounce due to humongous demand of silver. Hunt brothers continued to take delivery and borrowed heavily to take out even more futures on silver once their immediate cash was all tied up.

Greed of Leverage

The investment of $1 billion worth of silver purchases was bound to move the market, but the Hunt Brothers were able to amplify this jump by leveraging the family fortune many times over with unprecedented rise in value of silver. At one point of time, name of Hunt Brothers was considered as goodwill where lending was concerned, and the Hunts were able to get capital at much lower rates than other speculators. They preached their gospel of silver as the true haven in the upcoming inflationary flood to wealthy investors throughout the world and pooled converts’ funds to buy up more silver and futures contracts. Even investors from Middle East (Specially Saudi) started taking interest in Silver market and started investing in Silver.

The famous Silver Squeeze
Both Hunt brothers had already considerably reduced the physical silver available in the market and made their continuing buying action all the more powerful by rigging up the prices of silver. In any derivative segment, there are longs and shorts, but in this case, the shorts were vastly overmatched with longs. A short squeeze in silver was formed as the brothers continued to buy up available silver stocks and take delivery on their futures contracts. At the start of short squeeze, the Hunt brother’s position was worth around $4.5 billion. People were readily selling silver coins and silverware to take advantage of the high price of silver, but there was less than one third of the silver market left that the Hunts did not control via futures. The mania was at peak.

Regulatory Action

The U.S. Government became more and more concerned over what it saw as a clear attempt at manipulating the nation’s silver reserves. Further, more concerning was the fact that this corner involved the Middle East added some venom to the government’s reaction.

In order to curb the manipulation in Silver market, Federal commodities regulators introduced special rules to prevent any more long position contracts from being written or sold for silver futures. They temporarily suspended the fundamental rules of the commodities market which stopped Hunt brothers from increasing their position in future contracts. However, shorts were free to pile in which resulted in fall of prices of silver. Fortunes created by Hunt Brothers then turned into horror movie as Margin calls on the loans began to take a toll on the Hunts’ reserves to the point where they were paying millions a day in calls, storage fees and interest.

The famous Silver Thursday
Due to the Goodwill created by Hunt Brothers, the access to low cost capital was easy for them which kept them afloat to meet out the margin calls. However, the Federal Reserve then took an unusual step. They directed banks to stop lending loans for speculative activity. By the time, it became very clear that the government was after the Hunt Brothers, their credit dried up all of a sudden. Fear of defaults in margins put further downward pressure on the prices of silver. Finally, the day arrived when the bubble got completely pricked.  On March 27, 1980 (Black Thursday), the Hunt brothers missed their margin call and the silver market plunged all of a sudden, dropping to under $11 from its high of $48.70.

Post Aftermath of shock
Government considered to bailout financial institution to prevent systemic chaos. The action was vetoed, however, because the government agencies didn’t want to be seen directly as underwriting dangerous financial speculation. In the end, the Hunt Brothers name was held true, and they arranged a private bailout from a consortium of banks and companies. Further, they were dragged in front of Congress, scolded, charged with manipulation, fined, fined again and forced into bankruptcy. It took nearly 10 years for them to unwind all their silver holdings and satisfy creditors, and the final bill left few billions poorer – although they remained wealthy by most standards.

The Sting of Irrational Excitement
Whether Hunt brothers purposely intended to manipulate the market or not, the Hunts created a bubble in the silver market singlehandedly. This severely shook the financial system. Whether stocks, silver, or sprawling suburban homes, too much “irrational exuberance” always comes back to bite the hand that feeds it as the revolt against the system starts on later stage when the seeds are planted by elites.

Softbank Whale in Tech Stocks

After describing about famous Hunt brothers Silver squeeze, we must move on to small Gamma squeeze of Soft Bank.

Softbank has large positions in various tech stocks like Uber, Lemonmade, Katerra, Amazon, Netflix, Microsoft etc.

It has also been buying large quantities number of call options on those same listed stocks.

The position in derivative contracts were so large that it moved prices to higher side. As per one report, the size of investment in derivative market was $4 billion on those options, an amount giving rise to perhaps $30 billion of notional exposure. Such exposure influences the price of stocks to move one way.

The analogy of buying call options means that someone is selling them. As prices rise as they have been some of those call writers are going to start covering their positions. This situation creates demand for the stocks, adding to the price and so a spiral can be created. The analogy worked well until the positions were masked. However, as soon as the positions of SoftBank got unveiled, the other investors started taking contrary call against Soft Bank bet. This forced Soft Bank to wind up its position in derivative market.

Though the incident was short but the practice remained prevalent till date. After the announcement of Vaccine news, the market exploded multiple times following this strategy but this time the faces in the market were many.

Game Stock Saga

Recently unprecedented moves in penny stocks have been noticed in US equity market where stocks like Game Stop moved up 26 times from 52 week highs, SRMX moved up 38 times etc. All such companies were completely divorced with fundamentals and they all had one thing common i.e. highly short position by big financial institution.

The chart above reflects picture of any long term Investment but the duration of this chart is less than a month. Within one month the shares of Games Stop soared to $486 from $39.36 creating buzz in wall street.

 The move in penny stock was revolutionary when certain large hedge funds like Melvin Capital lost 50% of its capital by shorting the stock. It was a most seminal events in capital market.  

Now how does this happen?

Without describing this Short squeeze (Gamma Squeeze) in detail, we will point out the main points of this event:

  • GameStop shares started to rise last summer when an investment firm owned by Ryan Cohen — founder of Chewy, the online pet supplies shop, bought a stake in the company. But during the same time, some hedge funds were betting against GameStop’s.
  • The company was shifting its focus on online commerce and streaming, but the pandemic was bruising it further.

Note: How does Short-selling works: An investor, who expects a stock price to fall, borrows shares of that company from another investor for a fee and sells it immediately, hoping that when the price does fall, they can buy the same shares back  at reduced price, return them to the owner and gets profit on difference portion.

However, the same trade becomes risky if the stock rises, the short seller is exposed to losses that are theoretically infinite as share prices can keep rising, while they can only fall to zero. So when a bet goes wrong, short sellers rush to repurchase the shares they borrowed so that they can return them and exit their trades — a process known as short covering.

  • That’s what happened with GameStop shares. When large number of retail investors began to buy up its shares and options — many of them were influenced by Wall Street Bets and other forums on social media. At the same time, stock began to surge, forcing the short-selling hedge funds to buy back the borrowed shares at a higher price, which itself pushed the stock price higher. In financial market language, this is a “short squeeze”.
  • Melvin lost over $7 billion in just one week due to this incident. What is even more stunning is that its promoter Citadel and Point72 further invested $2.75 billion as rescue financing. But the same failed.
  • However, to stop this mania famous trading platform app Robinhood banned the buying of shares like Game Stop, Nokia, Blackberry, AMC entertainment etc. Meanwhile other trading platform like webull also banned buying of Gamestop. Further Amazon Parler also goes offline too. Further the Discord also banned r/wallstreetBets server for few hrs. The same shares crashed from $486 to $50 within few days.

Conclusion

Why are we discussing and writing an article on short squeeze?

The current market conditions are devoid on any risk realization and mitigation. Markets and players will get exposed if they don’t take steps to protect their wealth. Leverage is an essential play for the stock market and derivatives market. But it cuts both ways. When exuberance reaches irrational levels, a single prick will be enough to deflate the bubble.

The stock market when evaluated on traditional parameters is in the highest percentile zone. The scope for years of underperformance exists. Investors are betting that the global central banks will be able to keep rates lower for longer while the governments worldwide are expected to keep stimulus running. This has created a complacency and investors are taking increased leverage positions to make a quick buck. The crypto currency market is only adding further to FOMO(Fear of Missing Out).

What history tells us is that such market conditions have rarely lasted longer than a few years but it can damage those who are at the centre of such events and collateral damage can be faced by those who want a piece of the play. Investors need to evaluate their choices carefully as the fear of missing out takes over.   

One thing that the current short squeeze event shows us is that if the irrational exuberance continues longer, the central banks will themselves be at risk of loss of confidence should the market fail. The current bull market is built on the fact that the pandemic has created a sudden demand due to scarcity as global supply chains got a pandemic shock. Not to mention changes in market dynamics and global environment is demanding more products and services. The question is while the consumers have seen job losses and increased dependency on stimulus money, could they continue to spend the same in an inflationary environment? What happens if the interest rates rise? What is the impact of excess stimulus on currency markets?

As long as the bull market continues, investors will keep ignoring these factors. The day the central banks are forced into action either due to rising yields or due to increased demand for stimulus to promote growth, the markets will face an immediate crisis, should they fail to control it. Investors are advised to be positioned for the same.

  • By Vishal Vora, Nishant Maheshwari

Disclaimer: The above article is based on views expressed by the authors and are meant for information purpose only. Readers are requested to take investment decisions by consulting financial advisors.

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