Trading
Bybit Learn
Bybit Learn
Intermediate
Aug 13, 2022

What Is a Gamma Squeeze & How Does It Affect Crypto Prices?

One of the key challenges of crypto investing is that huge changes can happen with little warning. In the event of a gamma squeeze, crypto prices will suddenly shoot upwards and increase far past the crypto's usual value. This might seem entirely random, but there's actually a method behind the madness. Understanding what a gamma squeeze is can help you identify future price increases.

What Is a Gamma Squeeze?

A gamma squeeze is an unusual type of price increase that happens in the crypto market. It typically occurs when options and other behind-the-scenes contracts force investors into buying stock.

Gamma squeezes are a rare occurrence in crypto investing. They happen when large investment companies start trying to speculate on crypto prices by buying options and other types of contracts. This puts a lot of pressure on the market, and other investors can end up in a position where they have to buy crypto to cover their losses. As more and more people rush to buy crypto, prices end up soaring.

To better understand the gamma squeeze, let’s take a look at a real-world example in the stock market. A gamma squeeze was behind the notorious GameStop squeeze of 2021. Traders had purchased a bunch of options with the intent of shorting the underlying stock, but then market conditions forced them into buying large batches of GME stock. The end result was sky-high GME stock prices.

How Does a Gamma Squeeze Work?

To understand the mechanics of a gamma squeeze, we need to understand certain details about how the crypto market functions. In the cryptocurrency market, some major financial players buy and sell various crypto-related contracts. These "market makers" tend to trade millions of dollars worth of crypto, and they will often participate in options trading, which lets them speculate on future prices. When these contracts go wrong, a gamma squeeze can occur.

The first step in a gamma squeeze is created when various major investors try to short a cryptocurrency. This investment means they are essentially betting that crypto prices will fall. They borrow crypto tokens to sell at current prices, and agree to later give the same amount of tokens back to the lender. If prices drop, the investor can buy cheap tokens to repay their loan. However, if prices rise, their contracts could put them in a position where they have to buy a lot of pricey crypto in the future.

Most investment firms shorting crypto have a policy of hedging their bets. If prices start to rise, they purchase some call options that will let them make money if crypto prices increase. This ensures they can make enough money to cover losses if prices rise above their strike price. Ultimately, all of this "required" buying from big investors causes a self-perpetuating cycle of price increases. Rising prices make major investors rush into buying crypto as a way of covering their losses, and then prices increase even more.

Factors That Cause a Gamma Squeeze

Gamma squeezes are somewhat rare because a lot of things have to happen simultaneously before a gamma squeeze occurs.

  • Institutional trader involvement: No crypto can go through a gamma squeeze when only individuals are trading it. You'll only see this type of squeeze occur when large investment companies are trading huge blocks of crypto at once.

  • High amounts of options trading: Conditions start to look right for a gamma squeeze when market makers are trading options instead of just buying and selling crypto. Therefore, you'll only see a squeeze happening on crypto available for sale on derivatives markets.

  • Small increases in crypto prices: In the hours before a squeeze starts, crypto prices need to start rising above the strike price on various options. This small rise triggers panic buying that eventually leads to a true squeeze.

  • Negative outlook on crypto prices: To be vulnerable to a squeeze, a crypto first has to look like an asset that will depreciate. Usually, squeezes take place after things like new government regulations, or famous crypto hacks that make it seem like prices will drop.

  • Fast-approaching option expirations: Squeezes usually happen because investors are desperately trying to avoid having to buy back a lot of pricey crypto right when their option expires. The shorter the trading window before the expiration date, the more likely a squeeze is to occur.

How to Spot a Gamma Squeeze

So how do you know when a random spike in the market is heralding the start of a gamma squeeze? There are a few simple features you can analyze to see if a gamma squeeze is occurring. First of all, take a look at the coin's trading volume. During a squeeze, there will be a tremendous burst in activity, as institutional investors rush to buy coins before they hit their strike price.

If you keep up with crypto and DeFi news, it’s usually easy to spot a gamma squeeze. These events are very uncommon — and come with a lot of opportunities to both make and lose money. You'll notice that everyone is talking about the crypto that's undergoing the squeeze.

The final way to confirm the squeeze is by looking at its volatility. The market for a crypto will be extremely volatile when a squeeze is taking place. Squeezes tend to cause extreme volatility because there are sudden, unprecedented changes in price. Instead of prices drastically rising and plunging, a squeeze will make prices go up and up.

What Happens During a Gamma Squeeze

A gamma squeeze plays out in three separate stages. The first thing that happens is an unexpected jump in a crypto’s price.  What’s more, the crypto's price might rise even though it's unpopular or has some issues with development. This unexplained price rise tends to result in a little bit of selling, as people holding onto the crypto hope to make a profit on the unexpected price jump.

Next comes the huge spike in prices. All of the institutional investors doing options trading start to buy in volume, because they're concerned about looming strike prices. At the same time, retail investors start hearing about the squeeze and buying up underlying stock in the hopes of profiting from the squeeze. At this point, prices can rise to unprecedented levels.

The final stage of the squeeze is the price correction. Because the high price isn't backed by any real-world value, the crypto won't maintain the price past a certain point. Usually, the price starts dropping when all the big institutional investors' call options start expiring. Once the price starts to drop, most investors will sell while they can — and the price drops even further.

Gamma Squeeze vs. Short Squeeze

A gamma squeeze shares quite a few similarities with a short squeeze. Both price cycles involve investors betting a crypto will fall and then accidentally ending up in a position where they have to buy it back at a higher price. In both cases, this will trigger a rush for both investors and casual traders to buy up crypto and prices will rise unexpectedly.

The main difference between a short squeeze and a gamma squeeze is in their magnitude. Short squeezes can take place whenever retail traders are investing in crypto. Meanwhile, gamma squeezes only occur when institutional investors get involved. These market makers handle larger volumes of crypto at once, so they influence the market more drastically.

You can also distinguish between a short squeeze and a gamma squeeze by looking at the types of contracts being sold. Short squeezes can occur with a variety of investment strategies. Meanwhile, gamma squeezes only occur when there's a huge number of short-dated call options being purchased. This causes the upward spiral that creates such high crypto prices.

Gamma vs. Delta

When considering gamma squeezes, make sure you aren't getting gamma and delta mixed up. These are both Greek letters that are frequently used in math and finance, so it's no surprise people get confused. They're also both terms used by institutional traders, and they both relate to the eventual outcome of a squeeze. However, they do technically mean different things.

Delta is a type of measurement used to analyze put and call options. It measures how much an option price varies in relation to the underlying stock or crypto. Delta varies between zero and one. The closer it is to zero, the lower a crypto's value is compared to the option's strike price. If the delta is closer to one, a crypto's value is higher than the strike price.

Gamma takes this method of analysis one step further. It measures the change in delta, compared to the amount the price changes. This shows an investor how market changes are influencing their options. Higher gamma levels mean the investor needs to buy proportionally more stock to manage their hedges. This ever-increasing need for more stock is where the name "gamma squeeze" originates.

Benefits of a Gamma Squeeze

Gamma squeezes can definitely be … exciting. And trading during one of these squeezes can come with some major benefits.

Profit for Current Owners

One of the best positions to be in is to be the person who owns the crypto before the squeeze starts. Often, these investors have purchased their crypto for very low prices, so they stand to gain a lot. As long as they sell their tokens before prices drop, they can earn quite a profit on their crypto. These are the people you see who make millions off of a squeeze.

Opportunities for Savvy Investors

Because gamma squeezes always tend to play out in the same way, there are some neat trading opportunities. You can get involved in the derivatives market, and speculate on whether the price will keep increasing or start to fall. Once you spot a squeeze, you can also buy more crypto to sell before the dip happens.

Risks of a Gamma Squeeze

Though there are plenty of perks to this type of market scenario, it also comes with some major risks. Those who make the wrong choices can end up on the wrong side of the squeeze.

Pricey Tokens May Lose Value Quickly

If you buy crypto right before the peak of the squeeze, you might be in trouble. Gamma squeezes are very volatile, and the price can plummet at any point. If you time things poorly, you could be left holding almost worthless tokens — for which you paid a premium.

Unlimited Liability on Options

For those who like trading options on crypto, risks are even higher. The problem with options is that you can lose far more than just the initial amount of money you’ve invested. For certain types of options, a trader has to purchase a set amount of crypto by the time the option expires. There's no ceiling on how high a price can climb during a squeeze, so a trader could theoretically end up having to buy at a very steep price.

How Long Does a Gamma Squeeze Last?

The length of a squeeze tends to depend on what underlying factors were driving it. There’s no hard limit on how short a squeeze can be, so some may be over in as little as an hour. However, most squeezes last at least a couple of days. Some may last up to a few weeks, but none are sustainable enough to last for months at a time. Gamma squeezes usually end with a period of extreme volatility, in which crypto prices will drop and peak several more times.

How to Trade During a Gamma Squeeze

If you want to trade during a gamma squeeze, it’s best that you keep the following tips in mind.

  • Stay informed: The market can turn on a dime during a gamma squeeze, so you need to stay up-to-date. Traders do better when they research the event thoroughly before getting involved.

  • Only risk money you can afford to lose: During a gamma squeeze, you have to accept that the market will be highly volatile. Never go in with the mindset of "crypto prices always rise." Make sure the money you invest is money you're financially capable of losing.

  • Don't get emotional: Many people make bad decisions during a squeeze due to FOMO. It can be hard when you see so many people talking about “winning big.” Nevertheless, do your best to make logical choices — not emotional ones.

  • Skip the derivatives market: Options trading during a gamma squeeze is especially risky. Unless you have a high risk tolerance, it's better to stick to straightforward crypto trading.

  • Sell once you make a profit: It can be tempting to stay in the market with the hope of prices rising even more. However, you need to remember that gamma squeezes never last. You don't want to end up holding onto crypto long past the peak.

  • Pick a fast trading platform: With high volume trades and fast changes, a gamma squeeze isn't the time to make slow changes to your portfolio. Make sure you pick a reliable crypto exchange like Bybit that won't lag or shut down.

Should You Trade During a Gamma Squeeze?

Ultimately, a gamma squeeze brings some unique opportunities. If you have extra funds to play around with and are okay with high-risk trades, you can get involved. However, keep in mind that it’s also an incredibly volatile time — for an already volatile asset. Traders who hop onto trends without really knowing what they're doing can lose a lot of money. If you plan on trading during a squeeze, you need to take the time to do some market analysis and in-depth research. This can help mitigate some risks, but there’s still the potential to lose money, no matter how careful you are.

The Bottom Line

Whenever major industry traders are involved in crypto, their actions can put unnatural pressure on the market. If derivatives market actions bring about a gamma squeeze, you can expect sky-high prices before a sudden drop. This gives you the option of making a lot of money, but most experts recommend playing it safe. Getting too caught up in the hype can easily lead to losing your funds.