(Bloomberg) — The latest bout of meme stock mania, in which retail investors are pocketing quick fortunes by piling into heavily-shorted stocks like Kohl’s Corp. and Opendoor Technologies Inc., is likely getting some help from what Wall Street derivatives pros call a gamma squeeze.
A gamma squeeze occurs when a rising stock price forces options dealers who have sold call contracts to swiftly adjust their hedges, sending the price even higher. The wild swings can be seen in both directions, as the dealers buy into rallies and sell into reversals.
Trading in Opendoor is a good example. The stock price surged more than 300% from July 14 to July 21. On Monday alone, when the shares leaped as much as 120%, more than two million call contracts traded as well.
“One of the things that happens now is that the market makers adjust options pricing much more rapidly as they see a meme mania is going to happen, tracking Wall Street Bets and other social media platforms,” said Brent Kochuba, founder of options platform SpotGamma.
Other meme-worthy stocks with elevated short interest and options volume that’s at least double the 20-day average include GoPro Inc., Krispy Kreme Inc. and Wendy’s Co., all of which also popped at various points in Wednesday trading. AirSculpt Technologies Inc., Rocket Cos Inc., Beyond Meat Inc., WolfSpeed Inc., B. Riley Financial Inc., Hertz Global Holdings Inc., Inmune Bio Inc. and Hims and Hers Health Inc. are on the list well.
Gamma squeezes are similar to short squeezes, which were popular in the first round of meme mania, in that they force traders to respond. But whereas in short squeezes investors betting against a stock are forced to buy back shares to get out of their positions at a loss, gamma squeezes start in the options market.
The key distinction is who’s being squeezed and for how long, Kochuba said. Options market makers must continuously rebalance their hedges with a two-way flow buying into rallies and selling into reversals. Short sellers, on the other hand, scramble to cover their bets but typically exit the trade after the spike.
For example, the Kohl’s boom, where the stock jumped a record 38% on Tuesday, was more of a short squeeze in which traders betting the stock would fall rushed to cover those positions, sending the share price higher. Options flow, however, was relatively muted compared with Opendoor.
Of course, meme stock mania can quickly reverse, leaving investors and traders flat footed. As such, the exuberance of retail traders going after stocks with high short interest could be a warning sign that the broader stock market rally is nearing its end.
“We’re now seeing excessive bullishness,” said Eric Diton, president and managing director of the Wealth Alliance, citing the revival of meme stocks as well as rallies in SPACs and crypto. “I’m now at the point where I’m getting cautious.”
–With assistance from Bernard Goyder.
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