Hey Traders,
Meme stocks are back at it again this week, and there’s one in particular getting some extra attention …
AMC Entertainment (Ticker: AMC) was making headlines after news broke that Mudrick Capital had purchased 8.5 million shares of the movie theater stock at $27.12 … Before promptly selling them off for a profit the same day, declaring them “overvalued.”
Of course, when have Reddit Robinhood retail traders cared what Big Money’s doing? AMC barely faltered heading into the end of the trading day on Tuesday, with the shares still managing to close above $32.
AMC hourly chart courtesy StockCharts
But that’s actually not the most interesting thing I’m seeing from AMC today …
In the option pits, there’s been some heavy trading volume at some eyebrow-raising strikes.
I think this stock could be headed for a squeeze …
But maybe in a different way than most people are expecting.
We know retail traders have been targeting these meme stocks in an attempt to provoke a short squeeze, given the large amounts of shorted shares held by institutional investors.
However … AMC traders may be about to see a different type of squeeze play out.
First, let’s take a look at AMC in the option pits.
I’ve been noticing some really heavy buying volume on call options with strike prices that are quite a ways out of the money.
For example, take a look at the June 4 73-strike call.
(Reminder: AMC closed at $32 on Tuesday — just three days before these options were due to expire!)
AMC June 4 73-strike calls saw 60k trading volume with a delta of 0.06.
For this option to expire in the money, AMC would have to tack on more than 127% over the next three trading days … And there’s about a 2.5% chance of that happening.
But the trading volume still hit 60,000 contracts!
And that’s not the only peculiar option buying volume I’m seeing.
I’m seeing similar action at the June 4 50-strike call, with 33,000 contracts crossing the tape …
And the perhaps less outrageous, but still far out-of-the-money June 4 40-strike call, which saw over 75,000 contracts traded …
What’s going on here? What does all this call buying mean? Is there really someone out there who expects AMC to shoot up 127% by this Friday?!
Not quite.
Don’t get me wrong. AMC has been making some nice moves on the chart – I’m not trying to imply it’s not. But it’s not making these kinds of moves. By Friday.
Rather, this looks like an attempt to trigger a gamma squeeze.
Let me explain.
A rise in call-buying volume raises the delta of an option.
In simple terms, delta is the rate at which an option’s price changes relative to a price change in the underlying equity.
For example, if an option has a delta of 0.5, this means the price of the option will increase by $0.50 for each $1 that the underlying increases. A delta of -0.5 indicates that the price of an option will decrease for every $1 change in the stock price.
Typically, an at-the-money call will have a delta around 0.5 (-0.5 for a put option). The further out-of-the-money an option is, the lower the delta, and the farther in-the-money an option is, the higher the delta. A higher delta indicates a higher probability that an option will expire in-the-money.
When market makers sell options, they don’t just sit their naked short call options, they hedge. Delta hedging is an important way that market makers reduce the risk they take on by selling options. They typically buy stock in the underlying equal to the delta of the option, giving them a delta-neutral position. That way, if all of their sold calls expire at-the-money or in-the-money and are exercised, they already have some number of shares on hand to fulfill these potential obligations. However, as share prices rise and the option gets closer to expiring in-the-money, the delta also rises … forcing market makers to buy even more shares.
Gamma indicates how much the delta will change as the underlying stock rises or falls in price. Gamma is highest when an option is at-the-money, indicating that a change in the underlying stock will have a larger impact on the delta of an option than when an option is farther out-of-the-money.
Now, as the delta of an option gets higher (indicating the option is getting closer to being at-the-money), market makers who have sold all these calls will be forced to buy the stock, as a way to make sure their sold call positions are hedged.
And of course, this pushes share prices higher.
And the higher share prices climb … the more market makers have to hedge, because more strikes are pushed closer to being in-the-money.
And in AMC’s case, the delta on these options is just way too high! They don’t make logical sense. (The delta is circled in red above!)
These options players have goosed the 50-strike calls to a 0.19 delta … And those do not have a 0.19 delta to them by Friday.
But the higher the delta, the more market makers will be forced to hedge …
What’s more, the vol on these options is also starting to get incredibly high. On Friday, the implied volatility (IV) of the June 4 50-strike calls was 415, and now it’s all the way up at 452 – that means implied volatility rose by nearly 40 points in a single trading day.
All in all, this is something I will be keeping an eye on.
To me, it looks like the making of a gamma squeeze.
We will have to see how these options play out into the end of the week.
Your Only Option,
Mark Sebastian
