Gamma Squeeze. Can a GameStop Incident Happen in Reverse?
No shortage of market craziness last week. In that spirit, we wondered about a hypothetical situation. In the same way Reddit traders have exploited a call option gamma squeeze to drive up Gamestop (and last year, Tesla and Apple), could they possibly achieve this in reverse? As in, buy lots of put options on a name that’s showing some weakness and therefore help drive that stock,and the indices, lower with a put gamma squeeze? One may think that since dealers are already short puts across their portfolio, pushing them further short could really destabilize markets.
Quite challenging to attribute probabilities to such a theoretical situation. But perhaps it’s comforting to note there are a few market traits that make it significantly less possible to materialize.
Short squeezes refer to upside moves, where there is no bound to price action. GME’s ride from $20 to $500 was an impressive 2,400% rally. Shorting a stock may at most return 100%. And there is very small probability of a healthy operating business to trade lower than some even ridiculously low level. Any viable firm’s price distribution displays an abrupt lack of observations lower than some threshold, however low that may prove. So, zero is out of the question.
Besides, rebound tactics for falling equity prices are more easily implemented by investors. There is no lending rate incorporated in derivatives prices; no need to borrow shares from your broker. On top of this, there are also lots of real money sitting on the sidelines who will be more than willing to bid catching the falling knife.
No doubt gamma can and will accelerate a downward move. We might experience a tradable decline, after which we will examine the how’s and why’s this has happened and reassess the market situation. But it’s a sloppy association between gamma and attempting to actually signal negative changes or predict the extent of adverse price moves. Negative gamma can often be a contrarian indicator. We would not expect it to provide meaningful fuel to the fire except for the first couple of days and, despite how intense it may become, it will not make history.
(For our savvy readers, an options-driven pressure on prices is immensely path-dependent. If the decline comes to a stalemate, vanna may kick-in and reduce the amount of shares dealers need to short to mitigate their risk. If volatility is quoted lower even for one day then hedging requirements for short-dated puts will have market-makers buy back shares, reversing the downtrend).