Professional investors were heavily shorting GameStop, a company on the border of bankruptcy. Retail traders saw the high short interest, talked between themselves in Reddit/4chan and have converged in mass to purchase the company stock.
As a result,
- The stock rallied from $4 to $380 in the space of two weeks.
- Many professional investors got badly burnt, and some had to request additional capital from their own investors. Retail traders ae enjoying their Shadenfreude.
- Option market-makers probably got laminated as well – overnight gaps of 100% are unforgiving, whatever volatility you trade at.
- There will be large winners and losers. Blackrock’s 13% stake in GameStop should represent a gain of $2.4 bn. The short position is probably worth $19.5 bn combined at the current level.
- The stock may be very volatile in the short term, but I have no doubt how the story will finish: the stock will go be back down. If the company was worth shorting at $4, it surely still is at $400. To start with, we can imagine that the founders of the company, may jump on the opportunity to get out, and they probably have a bunch of shares to impact the market. Other institutionals have VERY large pockets. If they also bunch together against retail, they will have a heavy weight.
- Unfortunately, “the market can remain irrational longer than you can remain solvent”, so the question is “when” rather than “if”.
- Let’s say that the stock goes back to its original $4 price. Those traders who were long at $4 will simply lose their gains. Those who bought at $400, on the other hand, will be in the red for $396. There will be blood on the kitchen walls when this happens.
- Retail traders are buying calls as well, and stock volatilities have gone up. Because market professionals will not take directional positions in vol, they buy the S&P vol (and the VIX) as a proxy hedge. This retail pressure probably explains in part why the VIX has remained so high, despite the fact that the COVID scare was 10 months ago and the market has rallied since. (See the second article below).
- Other stocks seem to have followed the same path: AMC cinemas (when theaters are closed!), Tesla, the FAANGs in some parts…
What it means in the long-term
There is a long-term reflection to be had about this situation:
- There is an obvious opportunity for abuse – think “pump and dump”, just not on pink sheet stocks now. Was the collegial move initiated by somebody with an existing long position? Can we even regulate a crowd behavior, even in the absence of a smart crowd manipulator?
- Robinhood has freed execution costs, employees work from home now, and many retail individuals have discovered the excitement of trading. That trend is here to stay. It is good that the public learns about financial markets. It’s not so great that some will lose their house because of their lack of experience.
- Robinhood still makes money on the flow – by selling it to market-making firms. They have used ‘misleading’ advertising techniques, at best, to cash in on the excitement.
- Also day trading is hard, and many stock traders still don’t make much money.
- Unfortunately, trading is not investing, and what goes up can go down. When the market is bull, the exuberance is fun. But the party will eventually be over, and the wake-up call will be unpleasant.
- Actually, the equity markets are way over-valued by all standards. There are many reasons for this – pension funds can’t buy bonds at such low yields, they still have to invest, they can’t go against a trend. And the Fed has kept confirming that they support the bond and equity market without interruption. So the markets keep on rising, despite the warnings from many analysts. We are currently seeing all sorts of predictions from professional expert opinions, ranging from doom & gloom to euphoria. The crystal ball has rarely been so hazy.
- There are therefore structural pressure for a nice bubble, and there’s not much that the regulators can do at this stage.
But maybe we should think of how to prepare for the crash, and also avoid a repeat of the purchase cycle again?