June 13, 2024

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Nvidia market cap jumps by $350bn amid ‘gamma squeeze’

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Nvidia has gained $350bn in market value in wildly volatile trading since it reported first-quarter earnings just over a week ago, driven in part by a feedback loop of trading in the chipmaker’s huge options market. 

The company was valued at $2.69tn by Friday’s close, more than JPMorgan, Berkshire Hathaway and Meta combined, despite a pullback at the end of the week. It has added roughly $350bn since May 23, when it announced surging revenue growth over the first three months of the year. At the peak earlier in the week its value had risen by nearly half a trillion dollars, growing by a sum close to the market capitalisation of Tesla in just a few days.

Although many investors have been drawn to Nvidia by its bumper earnings, analysts say the past week’s rally bears the hallmarks of a so-called “gamma squeeze”. In such a market phenomenon, bulk buying of call options — derivatives that give traders the right to buy at a preset price and which can pay off it a stock rises — forces brokers on the other side of the trade to buy shares in the underlying stock to protect themselves.

As Nvidia’s share price climbed this week, bullish traders purchased more and more call options, forcing brokers to purchase further Nvidia shares. This pushes the company’s share price higher, boosting demand for calls, all of which drives a self-fuelling cycle of further dealer hedging. 

“Nvidia has become a one-way wrecking machine,” said Charlie McElligott, an equity derivatives strategist at Nomura. Dealers who sold call options are having “to go out and buy Nvidia to stay hedged into the rally”.

Shares closed down 0.8 per cent on Friday, but the chipmaker has nevertheless dramatically closed the gap with Apple and Microsoft, for a long time the two largest companies on US markets.

Line chart of Market value ($tn) showing Nvidia catching up with Apple and Microsoft following latest rally

Gamma squeezes “need a trigger”, said Steve Sosnick, chief strategist at Interactive Brokers. “An earnings beat, raised guidance and a stock split . . . are all potential triggers,” he added, referring to a 10-for-1 stock split that Nvidia announced along with its earnings.

Such squeezes are not uncommon. The meme-stock rally of early 2021 that centred on video game retailer GameStop was another example of traders buying short-dated, out-of-the-money call options that forced brokers to snap up the company’s shares, driving a huge, if shortlived, rally. 

Unlike GameStop, Nvidia boasts profit margins above 50 per cent and has lately come to embody investors’ hopes about the potentially transformative effect on the global economy of generative artificial intelligence, a technology that runs on the company’s chips.

Even investors who think Nvidia’s rally may have gone too far have found the stock hard to ignore. “If you were designing a perfect momentum stock, Nvidia would be it,” said Aswath Damodaran, a New York University professor and expert on equity valuation, referring to companies that are borne upwards by their own past performance.

Excitement around generative AI and the Nvidia chips that underpin it has intensified to such a degree that “when Microsoft announces a huge capex [capital expenditure] spend [with] Nvidia the recipient of that capex spend, both stocks rally endlessly on the same news,” said Ritholtz Wealth Management chief executive Josh Brown in a note to clients this week. 

“It’s a carousel that feeds on its own momentum and everyone’s having the time of their life. Until one of that carousel’s ponies stumbles. Or some CFO somewhere looks at the spending, compares it to the actual return on investment, and decides to slow things up,” Brown added. 

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