A gamma squeeze is a market phenomenon in options trading where rapid price acceleration in an underlying asset compels options market makers to purchase more of that asset for hedging purposes, further exacerbating the price increase. Within institutional crypto options trading, this describes a situation where significant upward price momentum in a digital asset forces dealers holding short call option positions to acquire the underlying cryptocurrency.
Mechanism
The operational mechanism of a gamma squeeze is initiated when the price of an underlying crypto asset moves sharply, causing out-of-the-money call options sold by market makers to become in-the-money. To maintain their delta-neutral positions, market makers are then forced to buy the underlying crypto asset. This demand creates a positive feedback loop, driving the asset’s price higher and triggering further hedging purchases, intensifying the squeeze.
Methodology
Managing the risks associated with a gamma squeeze requires sophisticated real-time options analytics and dynamic risk management systems. Institutional crypto trading desks utilize models to continuously monitor their portfolio’s gamma exposure and simulate potential hedging requirements under various price scenarios. Strategic responses include proactive delta hedging adjustments, establishing strict limits on options exposure, and ensuring sufficient capital reserves to meet rapid increases in margin calls during such volatile market events.
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