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Money Stuff: Reddit Posters Pick the Stocks Now

Money Stuff
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Wall Street Bets

I am biased because I work in the media, and use Twitter, but I cannot shake the assumption that the people pumping stocks on Reddit's r/wallstreetbets board are in it for the attention. Now obviously they are in it for the money. They are in the business, or at least the hobby, of buying stocks, pumping them up on Reddit, and then, I suppose, profiting. But aren't they mostly in it for the attention? Now they have a Bloomberg Businessweek cover story. Is that not enough? You have won, "posters with handles such as OverthrowYourMasters and yolo_tron." You have received your tendies of media attention. Now can it stop? 

I don't know, here's Luke Kawa at Businessweek:

Even veteran traders have trouble dismissing a 900,000-user Reddit forum called r/wallstreetbets, or r/WSB for short, whose tips and tactics have shown an uncanny ability to push prices, at least for the short term. Hitherto sleepy companies such as Virgin Galactic Holdings Inc. and Plug Power Inc. went crazy shortly after being mentioned there. The board may have added a little froth to Tesla Inc.'s $90 billion rally.

The do-it-yourself traders of r/WSB are waging a kind of guerrilla warfare in the markets, trying to exploit what they see as weaknesses in the system to move prices where they want them. For anyone who wondered about where the small day traders who made the 1990s so wild went, meet the 2020 version. …

For Reddit's band of self-styled "autists"—a term of endearment, relatively speaking, that crudely leans into stereotypes surrounding extremely online people—the chief prize is "tendies" (chicken tenders, the treat an overgrown man-child receives for being a "Good Boy"). Figuratively speaking, tendies are the financial rewards that follow from a successful bold wager. 

Great, just great. We have spent the last, like, five years talking about a hypothetical future in which 99% of all stock-market investments are in passive index vehicles. What would it mean for valuation and price discovery and capital allocation? Well … this, right? It would look like this. Sober responsible people would invest passively in broad market indexes, stocks would mostly move in lockstep with broad macroeconomic trends, and the single-stock price action would come from weird online hobbyist speculation. The future is here!

A big part of the r/WSB story is about options: When they want to move a stock, r/WSB posters don't buy the stock, they buy call options on the stock. The theory is that this forces other people to buy the stock:

Members of r/WSB believe they've discovered a kind of perpetual motion machine in the interplay of stocks with options contracts, which offer a cheap way to bet on whether shares will rise or fall without buying the stock itself. It goes like this: Members make bets that rely on market makers, the professional middlemen who sell you a "call" (a bet on shares rising) or a "put" (a wager on a decline). Market makers, like good bookies, don't want to go out on a limb. When taking a bet, they lay off the risk. If someone buys a call, for instance, speculating on a rally, the dealer buys stock in the underlying company. If the stock rises, the dealer may have to pay out on the option—but that's offset by the gain on the shares.

When shares keep rising, managing the hedge entails buying more stock. That's where the Reddit set perceives a weakness. A favorite tactic on r/WSB is to swamp the market with call purchases early in the morning in an attempt to force dealers to keep buying stock. Up and up everything goes—supposedly. As the stock price rises, so does the value of the calls, often by far more.

We have discussed this theory before, during Tesla's wild rally, and I conceded that they've got a point. Not a perpetual motion machine, but a motion machine, sure. The machine runs on leverage. If you have $100, you can buy $100 worth of stock, and the stock will go up a little; your trade will be self-reinforcing. If you get a margin loan, you can buy $200 worth of stock, and the stock will go up a bit more; your trade will be a bit more self-reinforcing. On the other hand if the stock then goes down a bit, your broker might call more margin from you, and if you can't put up more money the broker will liquidate your whole position and the stock will go down. Trading on margin magnifies swings: You're buying more than you otherwise would be able to, but if the stock goes down you will have to sell more than you want to. This is all very well known, and a standard story of the Great Crash of 1929 that everyone learns is that the stock market went up as retail investors all bought on margin, and then crashed as all those margin positions were liquidated.

Options are a way to get leverage, too, and can work sort of like an extreme version of the margin loan. If you have $100, you can buy options on $1,000 worth of stock, and a dealer will go out and buy $500 worth of stock to hedge that option.[1] The stock will go up; your trade will be self-reinforcing, and if the stock goes up more in the afternoon then the dealer will buy even more stock, pushing it up even more. But if the stock goes down, the dealer will have to sell stock just when you least want it to. And as with margin loans only more so, if the stock goes down too much you will lose 100% of your investment. 

Kawa makes another point about r/WSB's love of options:

But suddenly bullish individual investors are putting their mark on the options market. How influential have they become? Typically puts are in higher demand than calls because traders are more interested in hedging against losses. That's often not the case now—with some stocks, demand for the bullish calls is higher. "This is not normal," said Amy Wu Silverman, an equity derivatives strategist at RBC Capital Markets, on Bloomberg TV recently.

In equity markets, downside put options usually trade at a higher price (implied volatility) than equivalent (same-delta) upside call options; this phenomenon is called "skew." One standard explanation for this is the behavioral one that Kawa gives: Options are mostly insurance and sensible investors are mostly long stocks, so they mostly need insurance against stocks going down; there is more demand for downside put protection than for upside call speculation.[2]

Another standard explanation is that the value of an option increases as volatility goes up, and markets are usually more volatile when they're crashing than when they're rising. ("Stairs up, elevator down," is the expression, but it is not just about investor behavior. It's also that a big valuable company is probably more stable than a small troubled company; as a company's stock goes up, it looks more like a big valuable company and less like a small troubled one.) If you buy a put to protect against a crash, and a crash happens, the put will increase in value both because the stock goes down (making the put more likely to pay off) and because volatility goes up. If you buy a call to bet on a rally, and a rally happens, the call will increase in value because the stock goes up (making the call more likely to pay off) but will lose some of that value on declining volatility. The put, when it increases in value, increases in value more, which means you should pay more for it today.

The r/WSB phenomenon sort of upends both of those stories. If investors are not careful owners of a financial-asset portfolio looking for insurance, but instead Reddit guerillas looking for fun leveraged bets, then the demand for upside calls will outstrip the demand for downside puts. The basic behavioral story of the options market—that it's for sensible investors looking to protect themselves against downside risk—is reversed. It turns out, at least in some names, that the options market is mostly for wild speculation. 

But the other explanation—call it the realized-volatility explanation—is also inverted, because r/WSB-linked rallies are wilder than most crashes. Tesla is up almost 90% so far this year, and its 30-day realized volatility is about 106%. Tesla's stock lost about half its value between December 2018 and June 2019, without its 30-day realized volatility ever getting above 77%. If you bought Tesla calls during the rally, you made money both on the stock going up and on volatility going crazy.[3] It now has a $144 billion market capitalization. Not so long ago, you might have expected a company with a $144 billion market cap to be kind of boring and stable, with robust predictable profits and a fairly steady stock price. Now, nope!

Another big part of the r/WSB story is about, uh, manipulation? I do not want to give you legal advice, but as a general matter, for entertainment purposes only, I will say:

  1. If you like a stock, and buy it, and go post on Reddit "I like this stock and bought it and here is why," and other people are persuaded by your reasoning and buy it too, pushing the stock price up, then good for you, smart trade.
  2. If you like a stock, and buy it, and go post on Reddit "wouldn't it be funny if we all buy this stock to push the price higher and then offload it to unsuspecting n00bs who are attracted by the price action," and your Reddit buddies are persuaded and you all go and do that, then that might be market manipulation.
  3. If you buy a stock and go post a bunch of lies on Reddit about how great the company is and how it has discovered a cure for cancer that will be announced imminently, and other people read your lies and are persuaded and buy the stock while you sell it, then that might be securities fraud.

And one natural result of r/WSB's effect on the market, and of the attention it gets from the media (sorry!), is that more posts on the forum will tend to be in categories 2 and 3, because now those categories can work. You need an audience for manipulation, and now you can get one. Byrne Hobart notes that an audience for manipulation might attract professional manipulators; "in equities, the scalable professionals are either a) people who work in the industry and are constrained in how much they can tout, and b) criminals."

Last week the moderators of r/WSB banned a user with an unprintable name, and explained their decision like this:

The influx of media attention over the past week on SPCE and LL has made it clear that some users are attempting to use this forum to pump their positions (against Rule 8 of the sub). In addition, the sub has seen a rise in users resulting from media attention and r/all over the past few months. Recently, some pumpers have attempted to leverage the size of this community to pump stocks.

They went on ("DD" is r/WSB's term for "due diligence," i.e. a research report on a stock):

The user took a position on a highly shorted, small cap company ($LL has a short interest of 38%, $MIK at 49%)

The user posted DD on this sub on the name. Due to the low attention span of users, a post of greater than a paragraph was taken as genius thinking. Users and others that visit the forum then bought calls in large amounts.

Ouch! The message is that if you go to that subreddit and type three paragraphs, you will get free money. It is hard to think of a better advertisement for manipulators than that.

BlackRock

Today BlackRock Inc. announced that its co-founder and vice-chair, Barbara Novick, is stepping down. The Wall Street Journal's retrospective on her career is rich in paradox:

The face of BlackRock's public-policy efforts, Ms. Novick built a lobbying machine that let the money manager avoid the regulatory burdens big banks faced, fueling the firm's transformation into a giant with $7.4 trillion in assets under management. She also supervised the firm's oversight over public companies. …

Ms. Novick was a regular visitor at Washington federal agencies and on a first-name basis with key officials. Under her leadership, BlackRock disseminated 138 memos on its viewpoints and 507 comment letters on everything from retirement issues to liquidity in money-market funds. Through lobbying and behind-the-scenes persuasion, the firm skirted designation as a "systemically important financial institution," a label that would have brought new regulatory costs. …

Ms. Novick took on academics when they raised questions about whether index funds could distort markets. She pressed the firm to fund research to attack the idea that large investors with a broad reach were inadvertently hurting consumers by causing companies to compete less.

She also supervised BlackRock's efforts overseeing and interfacing with the public companies its funds invest in. That function is drawing new scrutiny as BlackRock, on behalf of investors, has grown into one of the top five shareholders in virtually every S&P 500 company.

On her watch BlackRock grew into an investing giant that controls trillions of dollars of assets, provides risk-management tools for trillions more, is a top shareholder at every public company, has unlimited access to government officials, and is an influential voice on questions of market regulation and retirement policy and economics generally. Also though it is not "systemically important," that's another thing she did. The trick is to expand BlackRock's systemic importance in every possible way, while avoiding the legal status of "systemic importance." 

Or there's that paragraph about how BlackRock doesn't influence companies to all work together toward the same goal (raising consumer prices), followed by that paragraph about how BlackRock oversees all of the companies to make sure that they are working together toward the same goals (right now, protecting the environment). The trick is to have and exercise universal influence over public companies in ways that people like (pushing them to be more environmentally friendly and socially responsible and long-termist), and to disclaim universal influence over public companies in ways that people don't like (pushing them to be more profitable at the expense of consumers). 

I don't think any of those positions are wrong, by the way. It is kind of efficient for BlackRock to manage everyone's money: Most people should mostly index, index funds should compete mostly on price, and the biggest provider will probably be the lowest-cost one. If it's going to run everyone's money then it should advocate on behalf of its investor clients, both to government and to the companies where it invests their money. It probably isn't systemically important in a 2008-crisis, run-on-information-insensitive-liabilities sort of way, and imposing bank-style regulation on BlackRock (capital requirements for its mutual funds?) could be sort of nonsensical. BlackRock could probably do some good by advocating for good governance and environmental practices, and it loudly does that; it might or might not be able to do some harm by advocating for reduced competition (see below), but it definitely does not do that in any explicit or visible way. It all feels like a more or less rational outgrowth of rational processes.

Still the result is weird. Novick's legacy is that she was central to building perhaps the most systemically important institution in modern finance, and that she made sure it wasn't systemically important.

Should index funds be illegal?

We talk about this theory all the time but the empirical basis for it is … let's say contested? Here (via Tyler Cowen) is "Common Ownership and Competition in Product Markets" by Andrew Koch, Marios Panayides and Shawn Thomas:

We investigate the relation between common institutional ownership of the firms in an industry and product market competition. We find that common ownership is neither robustly positively related with industry profitability or output prices nor robustly negatively related with measures of non-price competition, as would be expected if common ownership reduces competition. This conclusion holds regardless of industry classification choice, common ownership measure, profitability measure, non-price competition proxy, or model specification. Our point estimates are close to zero with tight bounds, rejecting even modestly-sized economic effects. We conclude that antitrust restrictions seeking to limit intra-industry common ownership are not currently warranted.

Who owns the Fed?

This is good trolling, I like this:

The question comes from foil-hatted conspiracists, good government advocates, and sober academics: Who owns the New York Federal Reserve Bank?

Under the Federal Reserve Act of 1913, each of the 12 regional reserve banks of the Federal Reserve System is owned by its member banks, who originally ponied up the capital to keep them running.

The number of capital shares they subscribe to is based upon a percentage of each member bank's capital and surplus. 

But the New York Fed – by far the most important of the regional banks – as a matter of policy has previously not disclosed the capital share holdings of its 70-plus member banks. … Now, thanks to a Freedom of Information Act request filed late last year by Institutional Investor, we know the truth. 

The answer is basically Citibank (with 42.8%) and JPMorgan Chase Bank (with 29.5%), though each bank gets one vote regardless of share holdings, the "shares cannot be traded, shorted, or pledged as collateral," and big banks get dividends on their money at the 10-year Treasury rate. It is not conventional share ownership. But next time Citi or JPMorgan does a bad thing you can be like "isn't it a scandal that this happened at a bank that controls the Fed," etc.

Things happen

Hunt for next chiefs puts Europe's banks to test. Yield on 10-Year U.S. Treasury Note Hits Record Low. Bob Iger Hands Disney's Reins to Parks Chief in Surprise Succession. Salesforce Co-CEO Keith Block Steps Down. Barclays Probe Signals 'Governance Weakness,' Activist Investor Says. Banks From UBS to BofA Rethink Operations to Cope with Virus in Asia. The Emperor's Old Bonds. Hilton's Waldorf Beverly Hills Used a Mole to Steal Secrets From Rival, Lawsuit Says. Why America Is Losing The Toilet Race. Jamie Dimon had a dream that coronavirus killed Davos attendees. "She says fiction is a sign the artist empathizes and understands a subject beyond simple observation, and he says all lies are used to mollify the proletariat."

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[1] Those are made-up round numbers but the magnitudes are fine. Tesla Mar. 20, 2020 $800-strike call options trade at about $62 per share against about an $800 spot price, with about a 55% delta, according to Bloomberg data.

[2] Let me tell a somewhat more general behavioral story here. Some investors own stocks and buy puts for protection, which drives up the price of puts. Other investors own stocks and *sell calls* for a bit of extra income, a "covered call" or "overwriting" strategy that tends to drive down the price of calls. Both of these strategies—paying to protect against the downside, collecting income by giving up some upside—seem like sensible straightforward conservative institutional strategies. The flip sides of these strategies—nakedly selling puts to collect a bit of income at the risk of losing everything if the market crashes, or nakedly buying calls as levered speculation on the market going up—feel riskier and sillier and less institutional, more the province of retail day traders. If you assume that the options market reflects the needs of sensible institutional investors, you will expect a normal skew (out-of-the-money puts trading at higher implied volatilities than out-of-the-money calls). If you assume that the options market reflects the needs of Reddit users, you will expect flat or even inverted skew.

[3] The rally was so weird that at one point the price of out-of-the-money Tesla *puts*—bets that the stock would go down—increased as the stock went up; the increase in volatility made them more valuable even as the stock got farther away from the strike price. As I tweeted, the intuition here is that "as vol goes to infinity the price of a put goes to the strike price": An infinitely volatile stock will trade at every possible number, including eventually zero, meaning that you can eventually exercise your put by buying stock at $0 and selling it at the strike price. When the volatility is realized on the upside—when the stock is volatile because it jumps wildly from $600 to $900—this is not entirely intuitive, but it's a *little* intuitive. A stock that quickly goes up a ton for no reason does seem to have a higher probability of quickly going down a ton for no reason. "Intuitively if you buy a 600 put with the stock at 700 and three minutes later it's at 900 the put ... obviously should be worth more," I tweeted.

 

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