The GME Story: Hedge Funds vs Little Guys

[CharminTide]

Note that this is A STORY and not to be taken as a financial recommendation. I'm laughably unqualified for that.

But this whole retail investor vs. hedge fund saga is fascinating to me.

For those who haven't been paying attention to this story, a notorious subreddit (a weird mix of financially savvy investors and memelords) noticed that GameStop (GME) was the most shorted stock on the market, and that the number of shorted positions actually exceeded the number of available stocks by 40-50%. So they started to buy GME, planning to hold it until those short contracts expire, thereby driving the stock price way up due to basic supply/demand. At that point, these hedge funds will either have to buy back their shares at a huge loss, or pay daily interest on every share held beyond the expiry date.

A poster on Bogleheads can explain the concept better than me, so I'll borrow their words:

Basically, Melvin [a big hedge fund] borrowed shares of GME from someone (could be you, could be me- brokerages lend out shares in exchange for a small fee all the time), with a contract to return them. Typically shorts are reconciled overnight, but that might just mean that they put up more collateral if necessary and pay the small fee again, and sometimes they're for a longer period. They sold those shares to someone else, on the theory that GME's price is heading lower, and that they'll rebuy them at a lower price and then return them to the original holder. If the price does indeed go lower, Melvin pockets the difference between the price they sold at and the price they bought at, less the small fee they paid. That's why it's called "shorting"- you're using an investment strategy that works only for the short term, vs "going long"- investing for the long term.

What happened here, though, is that the price has gone up and up- possibly because redditors were buying in, possibly because other institutions were buying in. That means that Melvin either has to put up more collateral, or it has to buy the shares back at an increased valuation, because they have to return those shares to the original owners. The theoretical danger- more of a real danger in this case!- is that if normally, if you buy a stock and it goes to 0, you've only lost the money you put up originally. If you borrow the stock and sell it, with the requirement that you rebuy it, your losses could be theoretically infinite- if the price goes up 10x, you have to buy at 10x the original value, which means massive losses. And that's exactly what happened here.

link

Yesterday, CNBC was extraordinarily hostile towards this Reddit play, while ignoring that this has been standard operating procedure for these funds for decades. Brokerage platforms started to limit sales of GME and related stocks. Nasdaq's CEO warned that they might pause trading on certain stocks to allow overleveraged institutions to "recalibrate." All of these moves play into the big guy vs. little guy narrative here, and I find this absolutely fascinating.

Here's a good interview on CNBC from yesterday that underscores that dynamic.

 

[CharminTide]

https://twitter.com/i/web/status/1354474147016024069

 

[B1GTide]

Gamestop is virtually worthless and this was done to make money at the expense of hedge funds. Hedge funds manipulate the markets every single day. Heck, every major fund attempts to manipulate the market in their favor every single day. I find it hilarious that the funds and markets don't care for this tactic. They are just mad that they didn't think of it first.

IMO, buying on margin and shorting stocks should be illegal. Stocks were not designed to be what they have become - essentially another trip to Vegas. The rules are changed to allow the rich to get richer at the expense of the less fortunate in every aspect of our lives.

 

[CharminTide]

I wouldn’t go so far as to say that margin investing or shorting are inherently bad, but shorting more stocks than are available to trade *is* bad. (and actually illegal, but rarely enforced because the SEC and Hedge Fund managers belong to the same golf club)

All Reddit did was identify naked shorting on GME, make that information public, and the hivemind did the rest, because figuring out how to profit off that isn’t very hard if you have enough buy-in. The fact that the investment oligarchy is up and arms and asking the SEC to ban this practice (what practice? Fully public, *outsider* trading?) essentially diagrams the wealth gap in this country.

 

[MobtownK]

Robinhood ought to change it's name after shutting down GME this morning.

 

[CharminTide]

Robinhood ought to change it's name after shutting down GME this morning.

Yeah. Not sure how it's anything other than overt market manipulation. Also not sure how RH survives alienating their core userbase right before their IPO.

For those unaware, RH only allowed sell orders for a handful of stocks this morning (notably, GME). You couldn't buy it. Which drove down the price.

For those also unaware, Citadel Securities is a market maker that handles most of RH's orders. Melvin Capital was the main hedge fund being hit by this strategy. Earlier this week, someone bailed out Melvin with an investment of about $2 billion. That entity was none other than Citadel Securities' parent hedge fund, Citadel LLC.

tl;dr RH routes orders through a company with a profound interest in driving down GME's stock price, and RH decided to shut down GME purchases for retailer investors this morning, which made that happen.

 

[UAH]

Yeah. Not sure how it's anything other than overt market manipulation. Also not sure how RH survives alienating their core userbase right before their IPO.

For those unaware, RH only allowed sell orders for a handful of stocks this morning (notably, GME). You couldn't buy it. Which drove down the price.

For those also unaware, Citadel Securities is a market maker that handles most of RH's orders. Melvin Capital was the main hedge fund being hit by this strategy. Earlier this week, someone bailed out Melvin with an investment of about $2 billion. That entity was none other than Citadel Securities' parent hedge fund, Citadel LLC.

tl;dr RH routes orders through a company with a profound interest in driving down GME's stock price, and RH decided to shut down GME purchases for retailer investors this morning, which made that happen.

My reaction to the story without having spent a lot of time with it is that it is surprising that any diversified hedge fund would be caught with a large naked short position particularly in a small cap stock with a narrow distribution of shares. Typically a fund would have call positions in place to mitigate what is essentially unlimited risk. If the principal trader involved did not have his position hedged we can be sure that his job security is very limited.

What typically occurs in these cases is that the thousands of Day Traders out there who closely follow short interest are involved in the stock and are the first to get caught on the short squeeze and of course when they are forced to buy back shares the stock makes a run to the upside.

BTW with this market in the speculative bubble it is in it is a good bet that the long-short funds are heavily hedged for downside risk. A manager I follow said that this is the time to avoid positions where forced sellers are involved, meaning mutual funds that will face daily redemptions.

 

[CharminTide]

I'm way out of my element here, so I may be entirely off base. But it's been upsetting to watch the market today, even from the sidelines.

I've never paid enough attention to see a short ladder attack in action -- basically hedge funds selling positions back and forth to artificially drive down the price, stop momentum, and trigger any stop loss orders -- but it seems like that's what's been happening today, with vast numbers of retail investors locked out from participating while institutions can trade at will. Doesn't sound like a free market to me.

Maybe a small fee on stock trades isn't such a bad idea after all, if this kind of institutional BS is the norm.

 

[UAH]

I'm way out of my element here, so I may be entirely off base. But it's been upsetting to watch the market today, even from the sidelines.

I've never paid enough attention to see a short ladder attack in action -- basically hedge funds selling positions back and forth to artificially drive down the price, stop momentum, and trigger any stop loss orders -- but it seems like that's what's been happening today, with vast numbers of retail investors locked out from participating while institutions can trade at will. Doesn't sound like a free market to me.

Maybe a small fee on stock trades isn't such a bad idea after all, if this kind of institutional BS is the norm.

I have read that the Stock Market is the largest form of regulated fraud on the globe. Mr. Market's main purpose is to move money from the many to the few.

 

[bdawg_jinx]

Doesn't sound like a free market to me.

Exactly, the fact that it is legal to prevent someone from buying a stock that they want to is absurd.

 

[crimsonaudio]

I think the most stunning aspect of this whole ordeal is the realization as to how many people didn’t appear to understand that the entire system was built by and for the ultra wealthy.

 

[CharminTide]

I think the most stunning aspect of this whole ordeal is the realization as to how many people didn’t appear to understand that the entire system was built by and for the ultra wealthy.

This is true.

But what RH and a few other brokerages did today was just a blatant illustration of a rigged market. It's one thing to play the game when you know you're at a disadvantage. It's quite another to play when you know the house is dealing seconds.

 

[crimsonaudio]

But what RH and a few other brokerages did today was just a blatant illustration of a rigged market. It's one thing to play the game when you know you're at a disadvantage. It's quite another to play when you know the house is dealing seconds.

Yah, this is so blatant - it's so obvious they're not even trying to hide it - that part is a little surprising.

 

[CharminTide]

Exactly, the fact that it is legal to prevent someone from buying a stock that they want to is absurd.

It's not just that. Circuit breakers are triggered all the time, and all activity on a stock is temporarily halted.

But that isn't what happened. Institutions could still buy and sell freely. But most normies could only sell today, not buy. Markets depend on a free exchange, and when one side is blocked from part of that exchange while another is not, you no longer have free exchange.

 

[92tide]

I think the most stunning aspect of this whole ordeal is the realization as to how many people didn’t appear to understand that the entire system was built by and for the ultra wealthy.

it's sort of like that adage i have heard about poker. the gist is, if you can't tell who the sucker is when you sit at the table, it's probably you.

 

[crimsonaudio]

 

[CharminTide]

 

[CharminTide]

 

[crimsonaudio]

I mean, this is genius. What a strange trip the last year has been.

 

[crimsonaudio]