Meme stocks shined. Opendoor up 14%; American Eagle up 9%; Krispy up 3%; Kohl’s up 2%
Few people would have picked Kohl’s stock as a candidate for a double. Thanks to a “gamma squeeze,” it became the latest meme-trade darling to gain more than 100% in a single day.
Kohl’s shot up 105% in intraday trading on Tuesday before finishing the day up 38%. The move wasn’t sparked by news—there wasn’t any. Instead, it was fueled by record options trading.
Kohl’s was among the most heavily traded stocks that day, with that activity ascribed to meme-stock traders like those who sent GameStop stock skyrocketing years ago and the hedging of options market-makers.
That explanation understates the coordinated efforts that are needed to create a massive stock move by identifying a heavily shorted stock, buying call options, and then drumming up interest on social media.
When done right—and it seems that many meme-stock traders have a talent for it—there’s an excellent chance a wounded stock like Kohl’s doubles in value in a single session. While Kohl’s stock has since declined, it was high enough, for long enough, for the engineers of the trade to make a lot of money.
Here is the meme-stock recipe for creating a gamma squeeze, which appears to be the case with Opendoor Technologies, Krispy Kreme, and GoPro, which all saw similar sharp moves this week.
As you’ll see, options gamma—an obscure way traders measure changes in the value of an options contract and associated stock—plays a role, but the activity is far more coordinated.
The first ingredient: Find a stock that can be easily pushed around. A heavily shorted stock is often a great place to start because it means that many investors have borrowed shares from their broker and sold them short in the market in anticipation that the stock will decline.
It also means that many investors are painfully sensitive to the potential of a stock rally. If the stock advances, those investors who have shorted the stock must buy it back at higher prices. If those investors panic, they create “a short squeeze,” which means they are basically competing with each other to buy back their stock at ever-higher prices. Kohl’s short-interest ratio is about 49%, which basically describes a pressure cooker.
The second ingredient: Buy at-the-money call options on the targeted stock. Such calls are basically the same as stock, but they have a superpower. Calls with strike prices that match the stock price often force options market makers to buy stock to hedge the stock’s gain.
Why? Because dealers always hedge risk, and when customers buy calls in anticipation that the stock will rise, the dealers must buy stock so they don’t lose money. The combination of aggressive call buying and dealers buying stock is what makes a stock like Kohl’s surge. The phenomenon is popularly called a gamma squeeze.
The third ingredient: Use social media to create awareness of the unusual stock and options trading. Make as many people as possible think that something extraordinary is happening, and that they should buy calls and stock. The social-media activity tends to create a huge wave of stock and call buying that the engineers of the gamma squeeze need to take profits.
The activity has a certain odor. Market regulators have done little more than watch from the sidelines. Rest assured, what happened with Kohl’s, GameStop, and so many other stocks will happen again.
