If you have been recently trading some of the fastest-moving stocks in the market, you have probably heard the phrase "gamma squeeze." Traders have found some situations in the SPAC sector where there has been a very high amount of redemptions when a SPAC deal is being concluded. In some cases, as many as 90% of SPAC shares have been redeemed by holders.
These redemptions leave a very small trading float because, in most cases, the PIPE shares that were issued to raise financing are still locked up and will remain so until an S-1 form is filed and becomes effective.
Aggressive traders have been targeting these situations because the very small float combined with a gamma squeeze can cause huge moves. Shares of IronNet Cybersecurity (IRNT) have more than doubled in a couple of days due to this dynamic.
A gamma squeeze sounds very complex, but it is a relatively simple concept, and it isn't necessary to understand what all those Greek symbols mean.
This is how a gamma squeeze develops:
When a broker sells a call option to someone, they are not looking to take the other side of the trade. The broker just wants to earn its commission and has no desire to carry any risk. The way that they do that is to sell the call to the buyers and then immediately buy an equal amount of common shares. That leaves the broker net flat. If the call is exercised, then the broker just delivers the shares that it bought to hedge the trade, and the transaction is closed.
The important issue here is that the broker doesn't care what price the stock is at. It just keeps paying whatever price is necessary to buy the required stock and offset the risk associated with the calls it is selling to customers.
If there is enough buying of calls and a relatively small float, this can create a positive feedback loop. The more calls that are bought, then the more stock that is bought and the higher the price of the stock goes.
Eventually, this will unwind, and the stock will fall sharply, but it is easy to understand how this dynamic can cause a stock to fly higher as buyers pile into short-term calls and a thin stock is pushed higher and higher as brokers hedge their positions.
There is a very high risk associated with these trades as they can unwind so quickly. This is the trade that caused a fund run by William Hwang to suffer a $20 billion loss in a matter of a few days. So if you are playing this game, then be aware of the high risk.
A few names that I own that have the potential for this type of action are AgileThought (AGIL) , TMC the metals company (TMC) , and Offerpad Solutions (OPAD) .
