Explanation: What is gamma compression and how did it drive up the AMC stock price?
Shares of AMC Entertainment Holdings Inc (AMC.N) hit an all-time high this week in a meteoric rally that once again highlighted how an obscure option market momentum known as gamma compression can increase. stock price gains.
WHAT ARE GAMMA OPTIONS?
AMC’s rally was fueled in part by intense trading in stock options. These financial derivatives give buyers the right to buy or sell stocks at a fixed price in the future, depending on where the stock price is.
As the share price evolves in the normal course of operations, the value of these derivatives fluctuates according to the evolution of the probability that the option buyer will exercise this right.
These changes are captured by a range of mathematical calculations, one of which is called gamma.
Anyone who sells options is a “short range”. Gamma is highest when the strike price of the options written is very close to that of the underlying stock.
WHAT IS A GAMMA SQUEEZE?
Market makers who sell options may eventually have to deliver the underlying stock, so they risk big losses if they have to pay more than they negotiated.
To hedge their exposure, they often buy or sell shares of the underlying stock.
In AMC’s case, hordes of call option buyers left market makers with a massive short gamma position that rose as the share price approached the high strike prices held. by bullish investors.
As the share price skyrocketed, market makers bought AMC shares to offset their exposure, adding more fuel to the recovery, analysts said. It is gamma compression.
CAN GAMMA SQUEEZE WORK BOTH WAYS?
Yes. It can be said that market makers are running out of gamma by selling options or put options. When a stock falls, market makers are highly motivated to sell the stock to hedge their exposure.
However, downward pressure on stocks from gamma-induced selling is generally less extreme than upward buying pressure, analysts said.
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