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Gamma - Acceleration of Change

đź’ˇ Become a Master of Gamma

In this article, you'll learn about:

  • Gamma, the Greek representing the sensitivity of Delta
  • Practical applications for Gamma
  • How to think about Gamma
  • Gamma Squeeze and how it works.

Γ Gamma - Acceleration of Change

Gamma is the rate at which Delta changes for each one-unit change in the price of the underlying cryptocurrency. It is derived from mathematical models used in options pricing, and Gamma is typically expressed as a positive value for both call and put options.

A high Gamma value indicates that Delta is highly sensitive to changes in the price of the underlying asset. It measures the acceleration of Delta, helping traders understand how rapidly their exposure is changing as market conditions fluctuate.

Gamma in practical situations:

  • Position Adjustment: Traders can utilize Gamma to anticipate changes in Delta and adjust their positions accordingly to maintain desired exposure levels.
  • Gamma Squeeze: Rapid increases in volume for ATM or slightly OTM call options on an asset result in buy pressure which squeezes Gamma upwards, cascading in a price increase before unwinding.

Gamma: High Gamma results in a more sensitive Delta.

Gamma Squeeze - How It Works

Sweet home Alabama Gamma. Let's look at how a Gamma Squeeze works in practice, and how traders can capitalize on it.

1. Set-up for a Gamma Squeeze:

  • A Gamma squeeze initiates with traders amassing significant volumes of at-the-money (ATM) or slightly out-of-the-money (OTM) call options on an asset. For our example, this asset will be Bitcoin priced at $25,000

2. Market Makers' Response is to start Delta-Hedging

  • Market makers aim to maintain a Delta-neutral position to mitigate risks associated with the options they've sold.
  • They buy Bitcoin to hedge the short options position, a process known as Delta-hedging, which you might remember from the previous article.

3. Escalation and Feedback Loop:

  • The additional buying pressure from market makers will initially drive up Bitcoin's price.
  • The rising price increases the Delta of the options, and consequently, their Gamma. Higher Gamma means Delta will now change more swiftly with price fluctuations.
  • The amplified Gamma necessitates further Delta-hedging by market makers, inducing them to buy even more Bitcoin to sustain their Delta-neutrality.
  • This buying further propels Bitcoin’s price, forming a self-reinforcing up-only loop.

4. Alternative Hedging Strategies:

  • Market makers may opt for buying/selling perpetual swaps or spot to manage their Delta.
  • Utilizing portfolio margin can lower margin requirements, facilitating more effective capital utilization and risk management.

5. Climax and Unwinding:

  • Eventually, the feedback loop burns out and the buying pressure begins to wane or the options start to expire, marking the peak of the Gamma squeeze.
  • Absent continuous buying pressure from market makers, Bitcoin's price may sharply revert, potentially to pre-squeeze levels.
  • Traders and market makers start liquidating their positions, potentially exacerbating price volatility.

Bitcoin Gamma Squeeze Simulation: Visualize a real-world scenario with Bitcoin initially priced at $25,000. The cascade of events triggered by massive options buying, subsequent Delta-hedging by market makers, and the cyclical nature of Delta and Gamma alterations, culminate in a Gamma squeeze, pushing Bitcoin's price to $30,000.

Key Takeaways

1. Gamma measures how Delta responds to price changes in the underlying cryptocurrency. This metric assists traders in forecasting Delta changes and fine-tuning their positions, proving especially beneficial for strategies such as Gamma scalping.

2. Gamma Hedging is crucial for mitigating risks associated with Delta's volatility. When skillfully implemented, it can yield profits in volatile markets by maintaining a delta-neutral position.

3. Gamma Squeeze is a phenomena where rapid increases in volume for ATM or slightly OTM call options on an asset result in further buy pressure which squeezes Gamma upwards, cascading in a large price increase of the underlying asset before unwinding and potentially retracing the move.

Test Yourself!

In a Gamma Squeeze scenario, what role do market makers play?

  • They sell the underlying asset to initiate the squeeze.

  • They set the price of the underlying asset at the beginning of the squeeze.

  • They buy the underlying asset in spot to Delta-hedge, creating further buying pressure and potentially driving up the asset's price.