First up, a word of warning – I’m not a propeller head. I mean I like to understand how things work and when the uber nerds and propeller heads start yabbering to each other I can generally keep up with the principals, but there comes a point where there are so many different concepts and strings that I’m trying to keep tags of in my mind that it eventually starts washing over me, and I’m reduced to nodding sagely while thinking “What the fuck are they talking about?”.
Normally when that occurs I usually go back to seek clarification of subjects of the conversation once they’ve finished their Vulcan mind melds – that won’t be occurring today. I’m not going to bother with much more of an explanation than, “I found that interesting.” So today I’m gunna try and explain things the best that I understand them and if I’m wrong so be it – feel free to correct me. Basically take this post with a grain of salt.
So the first thing I found ‘interesting’ was when I got a rare reply to one of my gonzo-crypto economic interests tweets, where I rubbished the latest example Michael Saylor furthers his credentials as anything other than an A-grade putz :
There is a strategy at Roulette tables called the Martingale strategy. Basically this involves betting a sum of money and then doubling that bet if you loose, and continuing to double until you win. Ultimately when you “win” you essentially walk away with the original small bet that you started with. This is all fine and dandy except that you have to be able to keep doubling your bets if you lose. I once went to a casino with a mate who deployed this strategy with an initial $10 bet on Red and then made further bets on Red as Black came up 7 more times. His last bet before busting out was $1280 and in the end he lost $2550 – quite a sum for a broke ass university student. Black actually came up a further 4 times, meaning he would have had to been prepared to bet up to $40k simply to win back his initial $10 bet.
Michael Saylor isn’t doubling down using the Martingale strategy, he’s doing something even stoopider.
Anyhow back to the point of interest, which wasn’t that someone responded to my tweet but rather what they were asking about, essentially asking what I thought about this thread (read the link for the full thread):
Now a negative gamma cascade sounds impressive but what exactly is it?
There is a lot of math in finance, one of the concepts is gamma. Gamma is part of that HSC 3unit math where you play around with derivatives in calculus. Gamma is actually the second derivative of an output price P1 in respect to an input price P2. It is often also referred to as convexity, which strictly speaking is incorrect as convexity is a measure of the curvature of the relationship between Bond prices, bond yields and duration – you don’t get a linear movement, but a curved relationship. Anyhow, in finance the terms are used interchangeably and are often used to explain unknown P&L variance when you supposedly have something that is supposed to be in a hedged relationship and the movements should be otherwise offsetting… but they’re not.
That is the key relationship we are talking about with Gamma – hedging. Basically using the price movement of one asset or derivative to “hedge” the price movement of another. While you might have a good ‘hedging relationship’ at one price, as the price moves to another that hedging relationship becomes less perfect and you will need to modify your hedge (this mechanical process is known as Delta hedging).
So as the gamma of an asset becomes increasingly convexed (curved) it may take more and more of P2 to hedge a price movement in P1.
A good example of this is what happened with GameShop, which was basically a gamma volcano. Long story short, basically a hedge fund shorted the fuck out of GameShop and a bunch of nerds who got into online trading during ISO initiate a short squeeze on the stock. But the mechanics of what happened is this:
- Hedge Fund was Short GameShop
- Nerds started buying GameShop Call Options
- Issuers of those call options started buying GameShop shares to hedge their position, causing price to rise
- Hedge Fund started losing money on shorts,
- Process repeated until, Hedge Fund finally cries out ‘Uncle’ and tries to close its shorts.
The original hedge fund can close its position in one of two ways, buying Puts to cover its short position, or buying shares to cover its short position. Generally puts are cheaper, because you don’t have to expend the entire notional of buying a share in order to acquire the hedging effect.
The problem is that although the best way to cover the shorts would be to buy an out of the money put, say a strike price of $100 when the stock price is $300, as these puts should be essentially worthless, the problem is though the hedging relationship has broken down and the holders don’t want to sell them.
Holders of those Puts know they are not worthless because they see the price spike from the short squeeze as being only temporary, and expect the price to fall back below $100 very shortly making their worthless puts hopefully worth something again very shortly. This means that the only way that the Hedge fund can cover their short exposure is to buy physical shares…. and this often results in the price finally surging way beyond reason or heights anyone could possibly imagine, as the Hedge fund buy at any price to stop the P&L pain.
A gamma cascade is the opposite. Basically the holder of the asset starts experiencing more and more pain the lower the price goes, until they get to the trigger point where they simply puke all their long positions onto the market in an uncontrolled fashion for whatever price they can get in order to stop their losses from continuing to grow.
What Michael Saylor has done, with all his BTC buying of 111,000 BTC via debt and convertible debt, is build an enormous doomsday machine at the center of the crypto economy. This chart tweet is another within the thread I linked above that does a good job of explaining this:
Essentially by telegraphing to the market both his position 111,000 BTC and his average buying in price of around $24k, what Saylor has done is painted a gigantic bullseye on the charts that the market price will inevitably gravitate towards.
To my mind a BTC price of $24k is now inevitable, the real question now becomes at what point below $24k will the MSTR fund be seized by its creditors as those debt instruments convert to equity and Saylor gets ousted in a flash, and they puke the entire 111,000 BTC onto the market for any price that they can get in order to recover their debt?
This is the infernal doomsday machine that now lies at the heart of the crypto economy.
I was reminded in a reply to Sacha below about another point that I meant to make above but forgot. It isn’t important enough to re-write or do another article in its own right, but it is interesting enough to mention, and centers on the question “Why can’t Saylor simply just sell BTC futures in order to hedge his position at $24k?”
Part of the reason for this is what was discussed above, the other part is credit risks. This is a thing that many traders ignore or forget about, until it becomes the ONLY thing they can think of or care about.
One of the best explanations that I’ve read on how it impacts Bitcoin future prices was by @Tr0llyTr0llFace. I’ll just leave it here with a “I found that interesting”.