The Game Stop Fairy Tale And Its Lesson

“A Gamma squeeze relies on the hedging actions of options dealers. The banks and brokers who are the largest sellers of options must hedge their trades. Most dynamically hedge, meaning they frequently adjust the hedge amount according to the Delta of the option.”

“If the Whale buys enough calls, they can trigger a Gamma squeeze. The option purchases force the dealers to buy the stock, which pushes the share price higher. As this happens, the dealers’ buying activity increases the Delta at a non-linear rate (gamma). In circular fashion dealers then must buy more of the stock, and on and on.”

Simply, dealers are forced to buy stock to hedge call options as prices rise.  Relatively low costing options trades can result in large share purchases by the dealers.

With the power of the traditional short squeeze amplified by the gamma squeeze, the game was on. GME shares went through the roof, hitting a high of $500.

GME, The Game Stop Fairy Tale And Its Lesson

Melvin Capital, a large hedge fund, was on the wrong side of the trade. The $13 billion hedge fund required a $2.75 billion bailout from fellow hedge funds Citadel and Point 72. There are many other victims as well.

The fun and games do not end with GME. Short squeezes are occurring in many smaller to mid-size companies with considerable short interest. The blueprint is working, and investors are following it.

GME, The Game Stop Fairy Tale And Its Lesson

 

The Fed’s Casino

While we hope you enjoy the tale, the underlying lesson is of greater importance.

Gotta admit it’s really something to see Wall Streeters with a long history of treating our economy as a casino complain about a message board of posters also treating the market as a casino” – Alexandria Ocasio-Cortez.

She is right, markets have become a casino.

The takeaway from our tale is not the winners and losers of an age-old trading game. What matters is the unprecedented level of speculation present in just about all asset markets.

Why is this? Significant consideration must be excessive monetary policy and how it reduces the level of perceived risk. Investors are blinded as the Fed has more than doubled the money supply in less than a year. The result is massive amounts of liquidity infiltrating the asset markets. Further, investors, rightly or wrongly, firmly believe the Fed will do whatever it takes to prop up ailing markets.

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