Tesla shareholders have had a wild ride since Tesla stock started to rise in early 2020. By the end of that year, it was up 743.44 percent. Share prices increased another 49.76 percent in 2021 before dropping more than 65 percent in 2022. The decline was partially due to the general drop in tech stocks and partially due to inconsistent leadership from Tesla’s unpredictable leader, Elon Musk.
Tesla stock is on its way back up in 2023. Year-to-date, shares have gained more than 135 percent. However, some investors and analysts have noticed that recent price increases may have less to do with the company’s actual or projected value and more to do with a Gamma squeeze in the market.
What is a Gamma squeeze? Did a Gamma squeeze cause Tesla to skyrocket? Most importantly, what does it mean for retail investors?
What Is a Gamma Squeeze?
The “short squeeze” got a lot of attention back in 2021 when GameStop stock went up hundreds of dollars in a matter of days. Essentially, traders who were short on GameStop stock had to buy shares back at much higher prices. Those with large short positions experienced devastating losses, and one hedge fund – Melvin Capital – closed its doors permanently after losing billions during the short squeeze.
Another phenomenon occurred simultaneously, though it got far less attention: the Gamma squeeze. It’s a similar concept, but it primarily affects options traders. Simply put, options are priced based on a mathematical calculation that considers several factors, including the market price of the underlying stock.
Options traders measure the Delta of their options to determine their exposure and/or profit as the underlying stock price changes. They also measure the Gamma – the rate at which the Delta will change as underlying stock prices get closer to the price of the options contracts. A high Gamma occurs when the price of the options contract is close to the actual share price.
A Gamma squeeze occurs when options traders sell large numbers of call options for the underlying stock. Remember, call options offer the option holder the right, but not the obligation, to buy shares at a predetermined price known as the strike price. Practically speaking, only market makers have the resources to sell massive quantities of call options. Fortunately, they also have the resources to hedge the associated risk.
The best way to hedge risk when selling call options is to own or purchase the underlying stock. As market makers sell all of these call options and buy up the underlying stock, share prices go up. The trouble is that rising share prices create more risk from the call options, so market makers have to buy more stock.
This cycle continues in what is known as a Gamma squeeze. The short squeeze plus the Gamma squeeze sent GameStop stock “to the moon.” As investors watch Tesla stock recover, the big question is whether the increase is the result of a Gamma squeeze.
Did A Gamma Squeeze Cause Tesla Stock To Go Up in 2021?
Tesla’s third-quarter 2021 results were far better than expected, and the company was particularly impressive when it was compared to other automakers. While the rest of the auto industry had to scale back due to chip shortages in 2021, Tesla managed to exceed analyst targets.
Call volume increased by a shocking 2,360 percent, and of course, the market makers selling those calls had to hedge their positions by purchasing Tesla stock. This led to a Gamma squeeze, and Tesla stock peaked on November 04, 2021. Is the same thing happening now?
Is A Gamma Squeeze Responsible For Tesla Stock Price in 2023?
A few astute Tesla stock watchers have noticed signs of a Gamma squeeze in the current Tesla stock price as it relates to the volume of call and put options.
One pointed out that the volatility skew, which is the difference in implied volatility (IV) between out-of-the-money (OTM) options, at-the-money (ATM) options, and in-the-money (ITM) options, is deeper into the call side.
That’s an unusual event unless the stock has a high percentage of short interest (SI) – shares that have been sold short and not yet repurchased by the short sellers. Tesla does not have high SI, which indicates a likely Gamma squeeze.
Is Tesla Stock A Buy?
Some of the excitement around Tesla stock is probably related to Musk’s remarks following the first quarter 2023 earnings report. Now that Musk has selected a new leader for Twitter, he intends to return his full attention to Tesla. He mentioned that the company will focus on developing its Artificial Intelligence (AI) capabilities. Two products are in the spotlight – FSD (Full Self-Driving) and Optimus, a humanoid robot that has learned how to walk.
However, neither of those products is likely to be market-ready short-term, and Tesla will have to navigate challenging economic conditions in the meantime. Yes, Tesla share prices might increase significantly in the coming years, but they are more likely to go down before they go up.
Watching Tesla stock rise has created a bit of FOMO (Fear Of Missing Out) among retail investors, and some are buying Tesla stock to take advantage of the current trend. However, as Warren Buffett has said on several occasions, “Be fearful when others are greedy, and greedy when others are fearful.”
Gamma squeeze increases aren’t supported by the company’s underlying value, and they tend to fizzle out as Tesla’s 2021 Gamma squeeze-related trend did. That fact, coupled with the current challenges Tesla is facing, suggests that retail investors should wait for the price to go down.
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