Bed, Bath, And A Stratospheric Squeeze

Bed, Bath, And A Stratospheric Squeeze
Stéphane Renevier, CFA

over 1 year ago5 mins

  • For a squeeze to work, you first need an inspiring bull thesis, and the support of the WallStreetBet army to get prices rising.

  • Then, you need a short squeeze and a gamma squeeze to really add some fuel and send stock prices into the stratosphere.

  • The squeeze game is a losing one for most investors. But if you’re determined to find the next short squeeze, look for stocks with high retail participation, a high short float, low trading volumes, and a big increase in short-term options open interest.

For a squeeze to work, you first need an inspiring bull thesis, and the support of the WallStreetBet army to get prices rising.

Then, you need a short squeeze and a gamma squeeze to really add some fuel and send stock prices into the stratosphere.

The squeeze game is a losing one for most investors. But if you’re determined to find the next short squeeze, look for stocks with high retail participation, a high short float, low trading volumes, and a big increase in short-term options open interest.

Mentioned in story

Bed Bath & Beyond (BBBY) isn’t the kind of stock that’d catch the eye of long-term fundamental investors like Warren Buffett. A struggling retailer with declining profits and no real competitive advantage, it’s got all the hallmarks of a poor investment. But its fundamentals weren’t in the driver’s seat when its stock quadrupled in the span of a few days last week, or when it crashed back down to earth. Let’s take a look at the four factors that sent its shares rocketing, and how you can spot the next big squeeze…

What sends a stock like this to the moon?

To understand how a stock like BBBY – or GameStop (GME) before it – can gain so much in so little time, let’s take a look at the four key ingredients to the gamma squeeze…

First, you need an inspiring bull thesis. Maybe it’s the promise of a significant turnaround, or a rumor that some big investor has been quietly buying the stock. In the case of BBBY, the news that billionaire activist investor – and retail champion – Ryan Cohen had acquired a huge stake, possibly in the interest of engineering a turnaround, bolstered sentiment.

Second, you need the so-called apes to rally behind the thesis. Individually, the apes (the retail investor crowd active in forums like WallStreetBets) don’t have much power, but in numbers, they can certainly move thinly traded stocks. In the case of BBBY, the stock quickly became the most talked-about asset on retail forums like WallStreetBets, and the most traded one on platforms like Robinhood and Fidelity, with volume reaching multiples of its typical levels.

Third, you need technicals that favor a “short squeeze”. When investors have taken short positions on a stock, and its price rises, they have to close their position by buying it back. That in turn pushes its price up, and leads to even more short covering and even higher prices. The higher the “short-float” – i.e., the number of shares being shorted as a percentage of total shares available for trading – and the lower the trading volume, the more the short sellers will be squeezed, and the higher prices will jump. In the case of BBBY, more than a third of its shares were shorted, while its trading volume was low enough to make the exit difficult for short-sellers.

Fourth, you need a large volume of out-of-the-money call options to create a “gamma squeeze”. This is the factor that really sends a stock to truly stratospheric levels. When investors buy a large number of out-of-the-money call options on a stock (contracts with a strike price that's higher than the market price of the underlying asset), market makers on the other side of the trade need to buy the stock to hedge their risk. That’s because if they didn’t and the price rose, they’d suffer big losses as the options seller.

And as Reda explained here, the more prices rise, the more shares the market makers will need to buy to hedge their risks. That’s because the sensitivity of the option price to the stock price (the “delta”) increases as the stock price increases, and the sensitivity of that sensitivity (the “gamma”) reaches its maximum when the market price reaches the strike price. And if a lot of call options were sold and trading volumes are relatively thin, then these buying pressures from market makers will push the price up, in turn forcing them to buy more shares to hedge their risk, and on and on, squeezing the prices higher.

Unfortunately, what goes up like a rocket often comes back crashing down to earth. That’s because when investors start to cash out on their positions, buying pressures ease and the gamma squeeze fizzles out. In the case of BBBY, the bull thesis took a sharp hit when Cohen announced he had exited his full position. Since he owned more than 10% of the stock outright and more than 1.6 million shares through call options, it also meant that the gamma squeeze was over. Prices have dropped 60% from their highs since then.

So should you try to profit from these short squeezes?

Honestly: no. Most investors should stay away from playing the short-squeeze game. It’s just extremely difficult to anticipate which stock will be squeezed and when it’ll happen. And in all likelihood, you’ll end up having to wait until the stock is already being squeezed to figure it out. And even if you do somehow manage to enter this trade at the right time, exiting can be just as tricky: prices can gap sharply lower, which could see you giving back all your gains before you know it.

But if you absolutely won’t be dissuaded, here’s how you might find the next short squeeze:

Look for stocks with a high retail participation: Swaggy Stocks, Fidelity, and Robinhood all share a list of the hottest and most traded stocks.

Look for stocks with a high short float and low trading volume: this screen from Finviz might help.

And, to find stocks with the highest potential for a gamma squeeze, look for big changes in short-term open interest and volumes, and strong short-term momentum in price. Or, to make things simpler, use this Fintel screen, which identifies the top 10 gamma squeezable stocks.

And, finally, if you do buy, you should seriously consider putting a profit target in place and using a trailing stop loss to limit your downside, just in case you’re wrong.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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