I blinked then thirty years elapsed in the life journey with my remarkable wife and business partner, Carrie. We just celebrated thirty years of marriage this week and it is has been, at least speaking for me, a heartfelt, satisfying milestone to celebrate.
To other geeks out there looking for love, here’s a thread of hope: I met Carrie preparing her personal tax return. That’s a fine rom-com storyline: Tax geek meets beautiful woman with income tax issues, convinces her to go on a date and then eventually to marry him. I’d like Matthew McConaughey to play me in the flick but he fails the geek test.
Well before COVID onset I pondered how to reward this amazing woman with a special vacation to reward her perseverance. Then COVID destroyed all my travel plans. We will embark to somewhere special someday, post-COVID, hold me accountable.
I’m happy to report our practice is busier now than a mosquito in a nudist colony. Hope you can say the same in your line of work despite the insidious COVID germ that kiboshed my anniversary trip to Margaritaville.
Right now, I don’t have the time to process the spate of market spectacles that keep surfacing in the news. Short squeezes, SPACs, crypto currency and then some.
Yet I must. This note takes aim at the recent Gamestop short squeeze event.
While it has faded from the headlines over the past couple weeks, for a while the Gamestop/Reddit/hedge fund battle was front page news, even besting the devastating Kim - Kanye divorce announcement.
Gamestop (“GME”), a beleaguered video game retailer, had responded well to new corporate leadership and its stock price had doubled in 2020.
Heading into 2021, however, the stock was still subject to a large amount of “short interest”. In English, that means institutional investors, mainly hedge funds, were betting in large volumes that GME’s sharp stock price rally in 2020 was a mirage and that it would recede big time during 2021.
To “short” a stock means to approach a brokerage company and “borrow” someone’s else shares in the target stock then sell them at the current share price. The lending brokerage firm charges a rather high interest rate for the stock “loan” and retains any cash dividends paid on the stock while the shares are on loan.
Consequently, short-selling is expensive and the short-seller better be damn confident the target stock’s share price will materially fall to allow for the repurchase at a lower price, return the shares to the lender and pocket the difference as profit.
Short-sale carrying costs can mount up quickly, so a typical short sale is not intended to be long-term position.
Short-selling financial risk is substantial. If the target company’s stock rises in value, the short seller could suffer unlimited losses. Think about it, if you sell a stock short at $10/share and it rises to $20/share, you would have to re-purchase the borrowed shares at $20/share to return them to the lender, even though you only received $10/share on the original sale.
The reality is that short-selling is best left for sophisticated investors.
Given that background, picture throngs of young dudes bantering about stocks on Reddit, a social media outlet, after Christmas.
One of the savvier Reddit dudes noticed that GME’s stock price was crimped by short sellers and hatched a plan to “squeeze” them. He convinced the Reddit throng to collectively purchase massive volumes of GME stock, which had the effect of pushing GME’s share price up sharply and quickly.
A short squeeze means the short seller is now upside down on the short trade and is forced to purchase shares in the open market to close out the position to cut losses. The extra buying traffic from hedge funds pushed GME’s stock price even higher, further enriching the Reddit investors – a savvy play.
Adding gasoline to the fire, the Reddit dudes purchased cheap out-of-the-money call options on GME. Since one call option controls one-hundred shares of stock, the leveraging effect of later exercising “in-the-money” call options on GME further squeezed the short sellers to the point of serious financial pain.
Unrelated to your grandma’s hug, a “gamma squeeze” is a Black swan (rare) event in which large volumes of “in-the-money” call options are exercised”, creating even larger buy-trade volume, which forces the target company’s share price to rise even faster, creating losses for option market makers and short sellers alike.
The Reddit investor cabal against GME short sellers was a smashing success. On January 8th, GME’s stock price was trading at $17/share. On January 29th, the share price peaked at $483/share, a 2,700% gain in just three weeks.
Then the controversy. In the final days of the short squeeze, Robinhood, the preferred online stock brokerage firm used by the Reddit cabal, suddenly announced trading restrictions in GME stock.
Many cried foul, accusing the hedge funds of muscling Robinhood to curb trading to stem their losses. Robinhood claimed they did it because could not deliver all the traded GME shares due to the volume crush in GME stock and options.
Can both be true? Who knows, but GME quickly became a pet rock by February with the stock price dropping into the mid $40s. The Reddit “Squeezers” took their massive profits then ganged up on other shorted stocks with good (but not equal) success.
Did the Reddit investor cabal do anything wrong? Not at all. Hedge funds were unhappy but that’s because they got beat at their own game. It will be a travesty if it turns out they did bully Robinhood to curb retail trading to stem losses; we may never know.
My concern is the casino attitude that has crept into the stock market. Investing is not a game. The GME story is a cautionary tale about how divorced stock prices can unhinge from their fundamentals in the short run. It also underscores how social media is now an incendiary factor adding to market distortion.
Until next time, be well….Tim