Read on Twitter
So, WTF is the story with GameStop, Robinhood, WallStreetBets?
I believe this is a bigger story and a key part of a Fourth Turning (H/T @HoweGeneration) when history looks back on this period.
Here's a summary of what's happened.
I believe this is a bigger story and a key part of a Fourth Turning (H/T @HoweGeneration) when history looks back on this period.
Here's a summary of what's happened.
The background to all of this has been @federalreserve policies, which have gone into overdrive since the bailout of the hedge fund LTCM in '98. This created a financial backstop for all of Wall Street, known colloquially as the 'Greenspan Put'.
Couple this with a rapid expansion in the Fed's balance sheet and reduction of interest rates towards 0% (or even negative in much of the developed world), the environment has been created for extraordinary risk taking & moral hazard.
With interest rates at say 5%, investment banks make money by borrowing at wholesale rates and lending to the public at retail rates, collecting the margin. But with rates at 0%, investment banks have needed to create all sorts of complex derivatives to generate yield.
Knowing that the Fed has their back, the last 25 years has seen an explosion in complex derivative markets. We saw this during the GFC where the fall of Lehman Brothers would've taken down the whole system if not for the Fed intervention.
Post-GFC the level of moral hazard & complexity in financial markets has accelerated, creating one big Frankenstein. 'Fundamentals' are long gone as a determinant for asset prices, it's now the derivatives that are setting the prices of the underlying securities.
Two excellent pieces of content on the complexity of todays markets have been produced by:
@vol_christopher
https://twitter.com/ttmygh/status/1324042350746808323?s=20
&
@choffstein https://twitter.com/choffstein/status/1304218462684950531?s=20
@vol_christopher
https://twitter.com/ttmygh/status/1324042350746808323?s=20
&
@choffstein https://twitter.com/choffstein/status/1304218462684950531?s=20
This leads us to the current situation with Melvin Capital. This Hedge Fund identified an opportunity to short a struggling bricks and mortar video games retailer called GameStop. Shorting it means they're selling shares today in something that they don't actually own.
A hedge fund does this in the belief that the price will go down in future - so when the contract is due to settle, they buy the shares at the lower price and pocket the margin. [eg sell 1M shares @ $10 today, settle contract in future with stock price at $5. 1M x ($10-5)=+$5M]
Of course the hedge funds are amplifying these opportunities, thanks to the Greenspan Put. In Melvins case, this meant they short sold more than 100% of the TOTAL free float of $GME shares outstanding. eg they shorted 100m shares when only 60m exist.
Things started to get challenging for Melvin in Sep 2020 when e-commerce legend @ryancohen acquired a large stake in GME with an aim to modernise its offering. This news pushed the price of the microcap stock up 29%. https://markets.businessinsider.com/news/stocks/gamestop-stock-price-chewy-cofounder-ryan-cohen-activist-investment-stake-2020-12-1029915366?_ga=2.181763943.1716102099.1611878106-899817127.1611878106
Meanwhile, a group of disenfranchised millennials began discussing an opportunity to screw some hedge fund elites in a sub-Reddit called WallStreetBets by amplifying the 'short squeeze' issues that Melvin were dealing with.
As you have sold shares you don't own, a rising price increases your liability. To reduce risk, you buy those shares in the open market, creating a 'squeeze' as your buying pressure is pushing up the price of something you want to go down.
To amplify the squeeze, the WSB crew began purchasing GME call options via retail brokerage platforms. A call option gives the owner the 'right to purchase' the underlying stock at a future date for a price specified today. These options are created by Market Makers like Citadel.
Market Makers have their own hedging to do when they issue options - as they need to fulfil those contracts in future if the options close 'in the money' (eg an option to buy GME @ $10 when the current price is $400).
Great thread on options markets here: https://twitter.com/SahilBloom/status/1283080850641317889?s=20
Great thread on options markets here: https://twitter.com/SahilBloom/status/1283080850641317889?s=20
Beyond the 'short squeeze' that was happening, the relentless buying of call options was simultaneously creating what's known as a 'gamma squeeze' for the market makers. The same phenomenon was a major factor in the 2020 tech rally. https://www.ft.com/content/75587aa6-1f1f-4e9d-b334-3ff866753fa2
Given the mainstream attention the trade has been receiving, GME has become big enough to be included in key indices. The mechanics of passive index funds means that the higher prices go, the MORE they need to buy. Read @profplum99 for more on this. https://twitter.com/profplum99/status/1354786610810769410?s=20
The positive feedback loop, or reflexivity, created what we've seen over the past week where its price went from $20 to $350. A perfect storm. Short sellers or market makers that issued contracts at $10 & haven't covered now have a liability of $340 per security.
Here's where things get interesting - because any trade thats been covered locks in a loss. Understandably, these big hedge funds are reluctant to concede defeat to a bunch of retail traders.
So whilst Wall Street sympathiser @CNBC are pushing all the right narratives for the hedge funds, including that Melvin have covered their position, the short interest remains at 140%. In other words, @ $350 some institutions are in a whole lotta trouble. https://twitter.com/ihors3/status/1354477089471295492?s=20
Now it's important to understand the relationships of the various key players - Melvin, Citadel & Robinhood.
One of Melvin's largest investors is now Citadel, the market maker who provided them with a $2.75B bail out this week as their GME losses mounted.
One of Melvin's largest investors is now Citadel, the market maker who provided them with a $2.75B bail out this week as their GME losses mounted.
Citadel, owned by Ken Griffin, is a major market maker and alternative asset manager with strategies that include high frequency trading. To support this, Citadel pays retail brokerage platforms like @RobinhoodApp for their order flow. https://www.ft.com/content/4a439398-88ab-442a-9927-e743a3ff609b
Yes thats right, they pay @RobinhoodApp, the same platform thats taking all these retail trades with 'free brokerage', almost 40% of their revenue.
As they say, if you're not paying then you are the product.
https://www.zerohedge.com/news/2018-10-16/robinhood-said-get-40-revenue-hft-firms-citadel
As they say, if you're not paying then you are the product.
https://www.zerohedge.com/news/2018-10-16/robinhood-said-get-40-revenue-hft-firms-citadel
What's followed has been an incredible insight into who really runs the world. The sheep in NYC & LA who celebrated Joe Biden's victory are quickly learning that the Presidency isn't really the office that influences things. Let's start with his Treasury Secretary, @JanetYellen.
Janet, the former Chair of the Fed, has spent the past few years earning a nice sum ($7.2M) in speaking fees from the big Wall Street firms including $810k in 2 years from our old friends at Citadel. https://www.forbes.com/sites/joewalsh/2021/01/01/yellen-earned-72-million-in-speaking-fees-over-last-two-years/?sh=38ca2f0e26f9
