Game? Stopped? ??? ??????Remember GameStop? GameStop Corp. common stock started the year at $18.84; at the end of January it briefly traded as high as $483 because people on Reddit's r/WallStreetBets forum bought a lot of it. There were call options and gamma squeezes and short squeezes; brokerages restricted trading in the stock as it got so volatile that it blew up their clearinghouse margin; we all had a good time. Then it ended. GameStop closed yesterday at $45.94. Oh well. Never mind. The whole thing was interesting and often very funny, but I do not think it was very important. Sometimes stocks trade at the wrong price for a while; sometimes there are bubbles and pumps and short squeezes; sometimes everybody sees the bubble happening in real time but no one can stop it. When this happens, people lose money, and people lost money on GameStop. But the people who lost money on GameStop seem to have been mostly (1) sophisticated hedge fund professionals who made reasoned risky bets that did not work out and (2) people who made self-consciously risky dumb gambles after reading r/WallStreetBets and pretty much got the gamble they paid for. Seems fine? The stock market cannot only be a casino; it has to serve the purposes of price discovery and capital formation and all that good stuff. But in order to serve those purposes it has to also be a casino, and it seems to me that the casino worked fairly well for GameStop. GameStop was the hot craps table with the excited crowd gathered around it. Everyone understood intellectually that the odds were against them and eventually the hot streak had to end, but look how happy everyone was! Look at the hugs and high-fives! Drink the free drinks! Isn't this great? Don't you want to gamble here too? Who cares if you lose some money? I guess this is all kind of a minority position. Today the House Financial Services Committee is holding a virtual hearing with the grim title "Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide," and I do not think anyone will be having much fun. Well, one person will probably have some fun, the person who has had perhaps the most fun of anyone throughout GameStop. That person is Keith Gill, who goes by "Roaring Kitty" on YouTube and by an unprintable name referencing value investing on Reddit. Gill was an early advocate for the GameStop trade; he spent hours on his YouTube channel analyzing it, and at his peak he was up almost $48 million. He'll be at the hearing. Here is his written testimony. It is really good! It hits all the standard notes for congressional testimony—I Didn't Grow Up Rich, I Worked Hard, Nothing I Did Was Technically Illegal—but it also manages to sound humble and human and friendly while displaying incredible panache. The penultimate sentence of his testimony is "In short, I like the stock," a defiant WallStreetBets rallying cry, and if he can say that with a straight face then you'll know he's having fun. I joked the other day about him bringing chicken tenders into the hearing room, but of course it's a virtual hearing and he'll be Zooming in from his basement, where he can have all the chicken tenders he wants. I hope he's got a giant bucket of them. I hope every time he gets a question he takes a big bite and chews very slowly before answering. He trolled the global financial markets for like a month, why not troll Congress for a few hours. Also his testimony is helpful if you want to understand the GameStop trade. For instance: I've been asked why I decided to share my investment ideas on social media. My investment skills had reached a level where I felt sharing them publicly could help others. I also thought that by sharing my own ideas and accepting critiques, I would be able to identify holes in my analysis. Hedge funds and other Wall Street firms have teams of analysts working together to compile research and critique investment ideas, while individual investors have not had that advantage. Social media platforms like YouTube, Twitter, and WallStreetBets on Reddit are leveling the playing field. And in a year of quarantines and COVID, engaging with other investors on social media was a safe way to socialize. We had fun.
The first part of this—hedge fund analysts share ideas and work together to refine their theses, but with social media now retail investors can do the same thing—is reasonable enough. The second part—when you can't leave your house it is fun to get together on social media to talk about stocks—is, I suspect, the core explanation of GameStop and the meme-stock phenomenon generally. I sometimes call it the "boredom markets hypothesis," the notion that people will trade a lot of stocks when (1) stock trading is relatively fun (because stocks are going up, for instance) and (2) nothing else is all that fun. In a locked-down Covid winter, not much was more fun than GameStop. And it's much more fun to all buy stocks together than it is for everyone to pick their own stocks. If everyone buys the same stock, then you can all share research and tactics, and make the same jokes about it, and sing parody sea chanteys. Also—this is key—if everyone buys the same stock then it will go up and you will all make money. Eventually it will go down and some of you will be left holding the bag and lose money, and the whole thing will have the approximate shape of a pump-and-dump scheme, and Congress will come calling and they will ask questions like "was this a pump-and-dump," and you will have to give answers like this: The idea that I used social media to promote GameStop stock to unwitting investors is preposterous. I was abundantly clear that my channel was for educational purposes only, and that my aggressive style of investing was unlikely to be suitable for most folks checking out the channel. Whether other individual investors bought the stock was irrelevant to my thesis – my focus was on the fundamentals of the business.
But the deep answer is, no, this was not a pump-and-dump, we just all bought the same stock at the same time because that's the fun way to do it. The other witnesses' testimonies are less fun. Still there are things to learn. Steve Huffman, the co-founder and chief executive officer of Reddit Inc., is maybe a little out of place at a hearing about the stock market, but he does have this to say: We have since analyzed the activity in WallStreetBets to determine whether bots, foreign agents, or other bad actors played a significant role. They have not. In every metric that we checked, the activity in WallStreetBets was well within normal parameters, and its moderation tools were working as expected.
"Bad actors" is pretty subjective, but if your theory of WallStreetBets is that evil bots were up-voting or down-voting certain posts to do the bidding of hedge funds, Reddit disagrees. Or here is the testimony of Vlad Tenev, the co-founder and CEO of Robinhood Markets Inc., the free retail broker that seems to be responsible for a lot of the surge of retail traders doing nonsense. Here's some data about Robinhood's customers: Overall, as of the end of 2020, about 13 percent of Robinhood customers traded basic options contracts (e.g., puts and calls), and only about two percent traded multi-leg options. … By offering zero-commission trades and no account minimums, Robinhood Financial opened up investing to a younger and more diverse group of Americans. The median age of our investors is 31, and about half of the customers self-identify as first-time investors. The median customer account size is about $240, with an average account size of about $5,000. As noted above, most customers appear to be investing in listed stocks and ETFs for the long-term. What we see is generally not consistent with popular memes suggesting that most of our brokerage customers are unsophisticated day traders taking inordinate risks with large sums of money on complex financial product. …
I dunno I feel like if 13% of your customers are trading "basic options contracts" on single stocks, that is … that seems high? I was a professional equity derivatives structurer for four years and I've never bought an option in my personal account. I'm not sure about "unsophisticated," or "inordinate risks," or "complex financial product," but if 13% of Robinhood customers trade options that does kind of sound like they're gamblers? Tenev also sheds some light on how Robinhood got a surprising margin call from its clearinghouse, and how it negotiated it down: At approximately 5:11 a.m. EST on January 28, the NSCC sent Robinhood Securities an automated notice stating that Robinhood Securities had a deposit deficit of approximately $3 billion. That deficit included a substantial increase in Robinhood Securities's VaR based deposit requirement to nearly $1.3 billion (up from $696 million), along with an "excess capital premium charge" of over $2.2 billion. SEC rules prescribe the amount of regulatory net capital that Robinhood Securities must have, and on January 28 the amount of the NSCC VaR charge exceeded the amount of net capital at Robinhood Securities, including the excess net capital maintained by the firm. Under NSCC rules, this triggered a special assessment—the "excess capital premium charge." In total, the NSCC automated notice indicated that Robinhood Securities owed NSCC a total clearing fund deposit of approximately $3.7 billion. Robinhood Securities had approximately $696 million already on deposit with NSCC, so the net amount due was approximately $3 billion. Between 6:30 and 7:30 am EST, the Robinhood Securities operations team made the decision to impose trading restrictions on GameStop and other securities. In conversations with NSCC staff early that morning, Robinhood Securities notified the NSCC of its intention to implement these restrictions and also informed the NSCC of the margin restrictions that had already been imposed. NSCC initially notified Robinhood Securities that it had reduced the excess capital premium charge by more than half. Then, shortly after 9:00 am EST, NSCC informed Robinhood Securities that the excess capital premium charge had been waived entirely for that day and the net deposit requirement was approximately $1.4 billion, nearly ten times the amount required just days earlier on January 25. Robinhood Securities then deposited approximately $737 million with the NSCC that, when added to the $696 million already on deposit, met the revised deposit requirement for that day.
Basically Robinhood got a normal margin call—its "VaR based deposit requirement"—for about $1.3 billion, because its customers were trading a lot of stocks that were very volatile. This margin call exceeded Robinhood's regulatory capital, which under the clearinghouse's rules triggers another, even bigger margin call. You can see why that would be a problem! We have talked about Robinhood's clearinghouse margin call before, and we have discussed the destabilizing potential of these margin calls: As things get scary and volatile, clearinghouses have a lot of unchecked discretion to demand huge piles of money from brokers at exactly the worst moment for those brokers. Here, precisely because Robinhood was so thinly capitalized, its clearinghouse had the right to demand even more money from Robinhood, exacerbating the risk of disaster. And then it just waived the whole extra $2.2 billion charge and said "ehh never mind you're fine," because Robinhood agreed to stop trading so much of the volatile stocks. Other things about the hearing might be less edifying. "'I don't usually do this, but I've spent like 10 hours on payment for order flow,' said Rep. Jim Himes (D., Conn.), a member of the committee," and that is way more hours than you need to spend on payment for order flow. (Here is my post about it.) Tenev has a little defense of payment for order flow, as does Ken Griffin of Citadel Securities, emphasizing that PFOF (1) is what allows for no-commission trading and (2) gets retail traders better prices than they'd get on the public stock exchanges. "In fact," says Tenev, "Robinhood customers received more than $1 billion in price improvement—the price they received compared to the best price on a public exchange—in the first half of 2020." None of this has very much to do with GameStop, but it is a perennially controversial thing whenever anyone is reminded of it, and GameStop reminded people of it so here we are. Another perennial controversy is short selling. Part of the bull thesis for GameStop was that a lot of hedge funds were short the stock, so if everyone on Reddit bought the stock there'd be a short squeeze; the short sellers would be forced to close out of their short positions by buying it, pushing the price up even more. And that does seem to have worked. So now here's this: Wall Street's main regulator is weighing whether to require more transparency of short selling and the opaque network of stock lending and borrowing that facilitates it, according to people familiar with the matter. The Securities and Exchange Commission was ordered 11 years ago to impose such rules but never did it. Now, dealing with the fallout from frenetic trading in GameStop Corp. GME shares, the agency under new leadership is considering using its authority to shine more light on the mechanics of the bearish trades. The 2010 Dodd-Frank financial overhaul law required the SEC to collect information about how much of each public company's stock has been sold short. The SEC doesn't gather or disseminate data on such bets by specific investors. House lawmakers meeting Thursday plan to examine the GameStop trading and discuss the dearth of short-sale data, according to a memorandum issued in advance of the hearing. The memo noted that the SEC hadn't completed its responsibilities under the Dodd-Frank mandate.
One witness at today's hearing is Gabriel Plotkin of Melvin Capital Management, a hedge fund that was short GameStop and lost a fortune when Reddit came after it. Here's how he describes Reddit's approach: In January 2021, a group on Reddit began to make posts about Melvin's specific investments. They took information contained in Melvin's SEC filings and encouraged others to trade in the opposite direction. Many of these posts were laced with antisemitic slurs directed at me and others. The posts said things like "it's very clear we need a second holocaust, the jews can't keep getting away with this." Others sent similarly profane and racist text messages to me. In the frenzy during January, GameStop's stock rose from $17 to a peak of $483. I do not think anyone would claim that that price had any relationship to the intrinsic value of the company.
I am not sure that the lesson I would take away from GameStop is that we need more disclosure of short sellers' positions? Or maybe it is, I don't know, maybe your takeaway here is "that short squeeze was awesome and we need more stocks rallying to irrational levels as short sellers are forced out." Seems weird though. Here is the committee memo for the hearing, which focuses mostly on short-selling regulations, though it also discusses Robinhood's role in the "gamification" of investing. There will be other vaguely-on-topic discussions; expect to hear a bit about T+2 or T+1 or real-time settlement. Tenev's testimony argues for real-time settlement—"There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time"—but my understanding is that most people who work in the plumbing of the financial system like to have a bit of time to line up funding and stock borrow and net out offsetting trades; Griffin, who is much closer to the plumbing than Tenev, argues for T+1. I doubt either change would have done much to change how GameStop played out. I don't know. Once you call a congressional hearing on a topic, you are pretty committed to the conclusion that the topic is serious and something should be done about it. You can't call everyone in and write memos and testimony and ask "what was this all about?" and have everyone reply "well we just thought it would be dumb and fun to do this, and it was" and then conclude "ah, well, as long as everyone had fun, carry on." But that might be the right answer. "In a year of quarantines and COVID, engaging with other investors on social media was a safe way to socialize. We had fun." It just cost some of them some money. Elsewhere in Roaring Kitty newsI hope that Keith Gill gets to spend the millions of dollars he made trading GameStop on something fun. "That money will go such a long way for my family," he will tell Congress today. "I always wanted to build an indoor track facility or a field house in Brockton," he told the Wall Street Journal last month, at the height of the GameStop drama. Sounds great. The man is a legend; let him live his dream. Build a field house in Brockton, why not, and put a giant statue of a golden chicken tender out front. He has earned it. I hope he doesn't have to spend all the money on lawyers: Keith Gill, one of the most influential voices that pushed GameStop on the WallStreetBets Reddit forum, was hit with a lawsuit that accused him of misrepresenting himself as an amateur investor and profiting by artificially inflating the price of the stock. The proposed class action against Gill, who adopted the YouTube nickname "Roaring Kitty," was filed Tuesday in federal court in Massachusetts. The suit said Gill was actually a licensed securities professional who manipulated the market to profit himself. Gill touted GameStop shares through an extensive social media presence on Youtube, Twitter and Reddit, where he used a more profane alias. "Gill's deceitful and manipulative conduct not only violated numerous industry regulations and rules, but also various securities laws by undermining the integrity of the market for GameStop shares," the suit said. "He caused enormous losses not only to those who bought option contracts, but also to those who fell for Gill's act and bought GameStop stock during the market frenzy at greatly inflated prices."
Oh come on, stop it. Here is the press release announcing the lawsuit, and here is the complaint. One basic argument is that Gill—who posted long YouTube videos that clearly express his honest opinions and analysis about GameStop Corp. and other stocks—was lying, committing securities fraud, because he neglected to mention that he worked at a financial firm. Blech: After purchasing a sizeable number of shares in GameStop Corp. ("GameStop") at prices around $5 per share, Gill used multiple identities to promote GameStop on written and video social media. He went by "Roaring Kitty" on YouTube – where cats and kittens are a favorite subject matter – and on Twitter and "DeepF***ingValue" on Reddit's WallStreetBets message board. In order to disguise that the aim of his social-media campaign was simply to increase the worth of his GameStop shares by creating a demand for the stock, Gill took on the fake persona of an amateur, everyday fellow, who simply was looking out for the little guy. He exaggerated and misrepresented the prospects of GameStop and made bold predictions about its future. ... Gill's direct and indirect actions in trading and promoting GameStop shares were designed to manipulate an increase in the price of the stock by deceptively using a "Robin Hood"-like persona to both induce "long" traders to purchase the stock and force "short" investors to also purchase GameStop shares to cover their short positions. ... By using a false identity, Gill failed to disclose his position as a regulated securities broker and industry insider and was able to mislead his media audience with his "every man" act and vilify securities industry professionals to incite his media audience to purchase GameStop shares so he himself could reap large profits.
The implication here is that if you watched Gill's YouTube videos and he said at the beginning "by the way I am a financial wellness educator at Mass Mutual," you wouldn't then go out and buy GameStop stock. "Oh, this man is a securities-industry professional," you'd say; "there is no way I am going to take his investing advice." I am not particularly convinced? More like the opposite? If he'd started all the videos saying "I am a professional financial wellness educator," you might have gotten a stronger impression that buying GameStop call options was good for your financial wellness. (Which it was, when he did it, but wasn't, when later, more bag-holding investors piled into the trade.) And then you'd buy lots of GameStop calls, and lose money, and sue Gill (and his employer, Mass Mutual) for misleading you, or for advising you to buy GameStop calls without inquiring into whether they were suitable for your portfolio or risk tolerance, or whatever. There's always something to sue over. I assume that this lawsuit is not actually directed at Gill, who is a folk hero, but at Mass Mutual, which is a big company with deep pockets. The case against Mass Mutual strikes me as even weaker than the (extremely weak) case against Gill but, you know, GameStop was in the news a lot, surely some plaintiffs' lawyers are going to sue someone, that is a law of physics. I hope Mass Mutual will pay for Gill's defense—he's getting sued for stuff he did as a Mass Mutual employee! sort of!?—and let him ignore this dumb lawsuit and spend his time building field houses. Still elsewhere in GameStop, here's "The Beach Bum Who Beat Wall Street and Made Millions on GameStop." Meme derivativesLast week we talked about how meme-stock issuers could have sold stock when everyone was briefly desperate to buy it, and about how at least one meme-stock issuer sort of accidentally bought back stock instead, and I suggested a trade: If you expect to be a meme stock—and nobody did a month ago, but now maybe you should have a plan for it?—then you should have a combination stock-issuance-and-buyback plan in place. Have a prospectus for an at-the-market stock offering that allows you to sell stock from time to time at market prices. Have a buyback agreement in place that allows you to buy back stock from time to time at market prices.
I added that you should "put them both on a 10b5-1 grid," so that you buy stock when it's low and sell it when it's high. The advantages are (1) you buy stock when it's low and sell when it's high and (2) you reduce the volatility of your stock: When it is soaring for weird meme reasons you keep a lid on it by selling stock; when it is crashing you buy some of that stock back. This was fine, just fine, but kind of boring, and as a former corporate equity derivatives structurer I should have done better. Aaron Brown emailed to remind me that this buy-low-sell-high trade is "exactly what convert arb guys do": If a company sells a convertible bond, then many buyers of that bond will be convertible arbitrage hedge funds, who will short some of the underlying stock to hedge their exposure. As the stock goes up, they'll short more of it; as it goes down, they'll buy back some of their shorts; either way they will help to reduce volatility in the stock. And if the stock goes up a lot, they'll probably convert their bonds into stock, which will have the effect of (1) reducing the company's debt load and (2) selling stock at a high price. So if you sold convertible bonds and then became a meme stock, that worked out well for you. For instance we have talked about AMC Entertainment Holdings Inc., the movie-theater chain, which became a meme stock. AMC took advantage of the frenzy in a number of ways, but one of the biggest was that it had a big convertible bond outstanding, and that bond converted into stock, vaporizing a lot of debt and leaving AMC in much better financial condition. This also probably had the effect of dampening volatility in AMC's stock, as the convertible owners sold stock as it was shooting up.[1] Or if you don't like debt you could sell warrants—convertible bonds without the bonds, just call options sold by the company—instead. Brown notes: So what the companies should really do is sell warrants—and puts to make it symmetrical. Imagine if GameStop had offered $500 10-year warrants to the market. It could have taken in a lot of cash and if the warrants ever get exercised—great. You get the same stabilization benefits of the issuance-and-buyback program, and you monetize the profit immediately and let investors do all the work.
Yes. You could sell puts too. At one point during GameStop's craziest week—on Friday, Jan. 29—a July 2021 listed call option with a $500 strike was selling for about $163.64; a July listed put option with a $20 strike was selling for about $6.75. GameStop could have found a bank and sold it puts and calls on a million shares for, let's pretend, $170 million.[2] At the time the stock was trading at like $325. If the stock fell below $20 by the end of July—very possible, since it started the year there—then GameStop would buy back a million shares at $20 per share. This would cost it $20 million, but of course it collected $170 million of option premium; the net result would be that GameStop would have $150 million and 1 million fewer shares. If the stock rose above $500 by the end of July—very possible, if you believed WallStreetBets—then GameStop would issue a million shares at, effectively, $670 per share (the $500 strike price plus the $170 of option premium it collected). Again GameStop started the year trading at $18.84, and at the time of this hypothetical trade it was trading at $325, so selling stock at $670 would be a huge windfall. And if the stock ended up between $20 and $500, GameStop would neither buy or sell any stock and just pocket the $170 million. Also by selling these options, GameStop would be working to counteract the crazy volatility created by the WallStreetBets crowd who were buying options. If GameStop sold these puts and calls to a bank, the bank would hedge them by buying GameStop stock as the price went down and selling it as the price went up,[3] with the result that it would go up and down less. For various reasons GameStop was not going to sell warrants or puts during its craziest week, but still there is something here. Perhaps if the meme-stock effect is real and enduring, then companies that might become meme stocks could do this before that happens. Sell long-term warrants, at least, and also perhaps longish-term put options,[4] collect some option premium, and then: - If your stock goes up to a crazy price, you get to sell stock at a crazy-ish price (the warrant strike price).
- Also the buyers of your warrants are selling stock on the way up (and buying on the way down), which makes your stock price less crazy and perhaps helps you sleep better at night.
- If you sell puts and your stock goes down you buy back stock cheap.
- If both things happen then you do both, selling high first and buying low later.
- If neither thing happens then you collected free money.
Also, crucially, by selling warrants (or convertible bonds, or some more structured version) before you become a meme stock, you avoid all the awkward questions from the Securities and Exchange Commission about selling stock during insane volatility. You effectively pre-sell the stock; you register the warrants and do your disclosure in normal times, and then they automatically become stock when things get weird. Anyway if you are a weird company and you expect the meme-stock bug to bite again, you should sell some warrants or convertibles. If you are a corporate equity derivatives banker, you should be putting together a pitchbook telling potential meme-stock companies to do this. Also of course you should brand it as a product and give it an acronymic name. There is actually some tradition of equity derivative products with cat names—"FELINE PRIDES" is a famous one—and I think that Reversible Optional Automatic Registered Issuance of New Good stocK If Things Turn YOLO (ROARING KITTY) would be a good name for this one. Things happen SPAC Boom Drives Credit Suisse Investment Bank as Trading Lags. Apollo Names Ex-SEC Chairman Jay Clayton as Lead Independent Director. SpaceX Funding Round at $74 Billion Valuation Was Led by Sequoia. CEO Charged With Choking Woman Garners Board Support, Not Rebuke. Barclays CEO Staley Expects Staff to Return to Office This Year. Gritty nude. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] The AMC convertible was not held by convertible-arbitrage hedge funds but by Silver Lake Management, a private equity firm that probably did not dynamically hedge by shorting stock. But Silver Lake *did* time its conversion really well, and it blew out of the stock during a high point in the meme-stock rally, which is sort of a concentrated version of the same idea: The stock got high, so Silver Lake sold a bunch of it, taking advantage of but also dampening the volatility. [2] That is a million shares of puts for $6.75 plus a million shares of calls for $163.64 is $170.4 million. "Let's pretend" because in fact a bank would not pay the company the same prices for a million shares as the listed market paid for a few, etc., but the numbers are not the point. [3] For a bank, the hedge for a long call is to sell stock short; the hedge for a long put is to own stock. As the stock goes up, the call is more likely to be in-the-money, and you have to sell more stock to adjust your hedge. (If the call ends up in-the-money you'll want to sell all the stock you get by exercising it.) As the stock goes down, the put is more likely to be in-the-money, and you have to buy more stock to adjust your hedge. (If the put ends up in-the-money, you'll want to own all the stock you have to deliver to exercise it.) And vice versa, etc. [4] It's awkward for a company to sell put options on its own stock: The accounting is bad, plus if your stock craters then that's probably a bad sign for your business, and you don't want to have to come up with cash to buy stock at that point. There are ways to do it; one way is a "prepaid put" (where you put up the exercise price up front and get back shares if it's exercised and your cash if it isn't), which isn't necessarily an ideal corporate-finance move for a struggling company. On the other hand if you couple it with a warrant maybe you've got something. | 
Post a Comment