JPMorgan Fears Gamma-Imbalance 'Fragility-Events' In These Stocks


Single stock option gamma imbalances have become a focus for market participants recently amid concerns of the role they may have played in recent price and volatility spikes in Technology stocks, and most recently in high short interest stocks. 

Specifically, SoftBank's “Gamma Whale,” which has now been replaced by Reddit-Raiders, provides a lesson on how a gamma squeeze operatesBefore explaining the scheme, we define option Delta and Gamma. As a quick reminder, we explained previously, delta quantifies the rate of change of the options price per the change in the underlying stock price. A delta of .50 means the option price will increase 50 cents for every $1 in the stock.

Delta is not a linear function, meaning it will not change proportionately with the stock price. Gamma quantifies how Delta will change per the change in the stock price. The chart below shows the non-linear “S-like” shape of Delta and the Gamma curve that warps it.

Options trade on leverage of sorts as a relatively small option premium can control many shares. In most cases, the premium is a tiny fraction of the price of the underlying shares. However, if the option is in the money at expiration, the option’s holder takes delivery of the underlying stock and must pay fully for the shares. In most cases, options traders sell the option or roll it to a future month to avoid payment.

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 Delta is .35, then they buy 35 shares for every option contract they are short. If the Delta then rises to .40, they buy five more shares. Conversely, they sell when the Delta falls.

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.

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