A market phenomenon that comes into play when dealers in CMS spread range accrual structures (CRANS) go from exposure being relatively flat gamma in a steep yield curve environment to significantly short gamma in an inverted curve environment – which causes the market to gap with increasing volatility. The payoff of a CRAN is typically a high coupon, multiplied by the number of days in a coupon period the curve is not inverted, divided by the total number of days.

CMS spread range accrual structures leave dealers short linear floors and long digital floors on the CMS spread between the two rates referenced in the notes. The digital floor, or put, is struck at zero CMS spread – that is, the dealer does not pay coupon on range accruals if the curve inverts. The short linear floor exposure arises from the fact that dealers are paying investors in CMS spread leveraged notes a linear factor multiplied by the CMS spread, floored at zero.

The gamma trap issue surfaces when the curve turns negative, which leaves dealers significantly short gamma. In this situation, instead of taking the opposite course of the market, which would result in hedging needs opposing the trend in swaps curve dynamics, dealers need to hedge in the same direction as the market, reinforcing the trend. This used to push 10s30s flatter in a rallying market. Thus many exotic dealers will need to rehedge via receiving the long end, which further exacerbates the inversion of the curve.