Gamma Squeeze Decoded: Why Wall Street's Hedging Creates Its Own Monster

You’ve probably heard the term “gamma squeeze” thrown around in crypto or stock trading communities. But most people don’t actually understand what it is—they just know it leads to chaos. Let’s break it down with real examples.

The Basics: What’s Gamma?

Think of options trading like this: when you buy a call option, you’re betting a stock will go up. Market makers (basically Wall Street’s liquidity providers) sell you those bets. But here’s where it gets interesting—they don’t just pocket the premium and hope you lose.

Market makers hedge their risk by buying the actual stock. The more calls they sell, the more shares they need to buy. This is where gamma comes in.

Gamma measures how fast a market maker’s hedging obligation changes as the stock price moves. It’s the acceleration pedal of options trading. When gamma is high, even small price moves force market makers to buy (or sell) huge amounts of shares to stay hedged.

How the Feedback Loop Works

Here’s where it gets wild:

1. Retail traders buy tons of out-of-the-money call options. They’re betting big on a stock. In GameStop’s case (late 2020), it was r/WallStreetBets coordinating a play.

2. Market makers sell these calls and start hedging. To protect themselves, they buy GameStop shares. Lots of them.

3. Buying pressure pushes the stock higher. The stock price rises, which increases the delta (how much the option moves with the stock). Higher delta means market makers now need to buy even more shares to stay hedged.

4. The loop accelerates. More buying → stock goes higher → delta increases → market makers buy more stock → stock goes higher again.

It’s a self-feeding machine, but it’s not based on fundamentals. It’s pure mechanics.

GameStop: The Perfect Storm

GameStop’s 2020 squeeze hit different because of the setup:

• Retail had cash. COVID stimulus checks + people stuck at home = traders with money to burn.
• Zero-commission brokers (Robinhood) made it free to trade.
• Massive short interest meant short sellers got caught in the crossfire as the stock rocketed.
• Social media amplification. Figures like “Roaring Kitty” could move the stock 20% with a single post.

The stock went parabolic, not because of earnings or business metrics, but because of the mechanics of options hedging meeting retail coordination meeting short covering. It was a perfect storm.

Why You Should Be Careful

Gamma squeezes are inherently unstable:

• They detach from reality. There’s no fundamental reason for the price; it’s pure momentum.
• Volatility is insane. Overnight gaps, circuit breakers, regulatory halts—anything can happen.
• Late arrivals get destroyed. Like musical chairs, when the music stops, the last people in pay the price.
• External catalysts matter too much. One tweet, one regulatory action, one news headline can pop the bubble.

The Bottom Line

Gamma squeezes are a real phenomenon in modern markets, especially with retail participation and options volume exploding. But they’re also why most traders should sit and watch rather than participate. The risk-reward is terrible for anyone not already positioned when it starts.

If you want to trade options, understand the Greeks. If you understand the Greeks, you’ll probably never want to trade into a gamma squeeze.