Is bitcoin experiencing a Gamestop-style gamma squeeze? Fielding questions from increasingly anxious speculators as the currency roared toward all-time highs during Tuesday’s trading session, Galaxy Digital researchers posted their estimate as of midday.
Citing Amberdata’s compilation of data from Deribit, a large bitcoin options exchange, Galaxy’s Head of Research estimated Deribit options dealers’ gamma exposure at $15 million per 1% increase in BTC price from $71,000 through $85,000.
In other words, bitcoin’s price is benefitting from a gamma squeeze. Before contextualizing this effect relative to other factors, however, it is critical to understand this mechanism of action without jargon.
Bitcoin dealers know their greeks
Gamma is simply the rate of change of delta, so we must first understand delta. Delta is a way to measure the price change of one asset when another, typically larger asset moves. Traders often construct “delta-neutral” portfolios, for example, if they don’t want their asset (#1) to respond to changes in a broad index (#2).
If someone has no exposure to delta, they are “fully hedged.” For such a trader, a gamma squeeze would have no effect.
Gamma squeezes occur when a trader, e.g. a sophisticated options dealer, is not delta-neutral but short delta. This dealer might have collected money over months of selling naked calls in hopes of crabbish, sideways price action.
Calls are a type of option that allow the owner to, as the name suggests, call an asset from the seller at a specified price before a specified date.
For safety, conservative investors only sell covered callsor options collateralized by an asset they already possess.
However, sophisticated options dealers often systematically sell naked calls or options collateralized by nothing. Selling naked calls is a surefire way to short delta and, by extension, short delta’s rate-of-change: gamma.
Gamma rises as options prices go parabolic
As the price of an asset rises, owners of calls will happily exercise their right to call an asset from their seller. To satisfy their contractual obligation, the seller must deliver that asset. In the case of a naked call seller, to be clear, they must buy backthe call or buy spot bitcoin and remit it to the call owner.
Both actions squeeze prices of calls and spot bitcoin upward.
Here, the effect of gamma on bitcoin’s price is clear. As bitcoin’s price rises, the delta of options quantifies the value of these calls accelerating in price faster than the price of spot bitcoin.
This faster-than-spot-bitcoin acceleration of call options is the gamma squeeze, which can ignite parabolically as bitcoin approaches popular, round-number strike prices.
(Gamma, or the rate of change in delta, usually rises the fastest as bitcoin nears psychologically important round numbers used in call options contracts like $70,000 or $75,000 strike prices. Gamma is almost always highest when the price of an asset is near an option’s strike price.)
As gamma squeezes naked call sellers, these short-biased dealers must panic into spot markets to buy back their naked calls, or buy real bitcoin. The forced buying of bitcoin by sellers of naked calls — enforced by options’ strictly enforced contractual obligations — is the mechanism that explains why gamma squeezes exaggerate the price of bitcoin during quick rallies.
Gamma, which is a rate-of-change phenomenon by definition, requires prices to quickly move upward to accomplish their squeezing of naked call sellers. Slow rallies allow dealers to easily hedge their gamma with affordable bitcoin and buy-backs of calls. Only quick rallies summon the gamma squeezes of Gamestop and AMC fame.
Read more: Does a bitcoin rally to $100K repay El Salvador’s IMF loans?
Bitcoin’s gamma squeeze in context
Now that the mechanism of action for a gamma squeeze is clear, how much effect did gamma have on bitcoin’s price during Tuesday’s rally? Were dealers as overwhelmed as Citadel call sellers during Gamestop’s nosebleeding squeeze?
In short, no. Although a gamma squeeze describes a real phenomenon in the bitcoin spot and derivatives markets this week, its notional size is inconsequential relative to bitcoin’s market capitalization and liquidity.
Specifically, bitcoin gains $14 billion for every 1% increase in its price — dwarfing the size of Deribit options dealers’ gamma exposure at just $15 million per 1% bitcoin price increase around this week’s price levels.
Moreover, bitcoin boasts over $50 billion in daily volume — again, dwarfing Deribit’s few thousand daily options contracts and sub-$2 billion in daily volume.
Granted, Galaxy only included Deribit gamma in its calculation, excluding other options markets like LedgerX as well as gamma in CME futures. Nonetheless, even if it had added these other venues, the overwhelming enormity of bitcoin’s spot market would still relegate the importance of options gamma to a relatively small contributor to Tuesday’s price rally.
