How'd the hedge funds do?I wrote yesterday that what I really want to read right now are accounts of how hedge funds made decisions when confronted with the weird price action in GameStop Corp. stock in the last couple of weeks. Clearly some hedge funds were trading the stock in incredibly choppy Reddit-driven markets, and I just want to know what they were thinking. Did they have some sort of robust tested process for trading based on momentum or social-media sentiment or technical factors, and coolly apply that process to the craziness around GameStop? Or were they distressed-credit or global macro funds who were like "this is too crazy, I cannot resist a trade like this"? The Wall Street Journal came through in a big way with this story about Senvest Management LLC, a (now) $2.4 billion equity hedge fund that made almost $700 million on GameStop. Their process for deciding how to buy GameStop was sort of boring and normal and pre-nonsense: They got interested in the stock after hearing "a presentation from the new GameStop chief executive at a consumer investment conference in January 2020," did research, "spoke with management, sussed out competitors and noted the involvement of activists in the stock." It took them until September to start buying, and "by the end of October, Senvest owned more than 5% of the company, paying under $10 a share for the bulk of the stock." Their process for deciding how to sell GameStop, however, really rose to the weird occasion: After the market's close on Jan. 26, Tesla Chief Executive Elon Musk tweeted "GameStonk!!" a rallying cry to users of Reddit's WallStreetBets forum, who had put their support behind GameStop. Senvest, which had slowly been trimming its position, decided to get out completely. "Given what was going on, it was hard to imagine it getting crazier," Mr. Mashaal said.
That implies that they got out mostly on Jan. 27, when GameStop closed at its all-time high.[1] They got into this stock based on fundamental research conducted over months; they called the top perfectly based on an Elon Musk tweet. Honestly I am tearing up a little? These guys get it. What a great investment process. I hope someone is working on a revised edition of Graham & Dodd that incorporates the Did Elon Musk Tweet Yet metric. The best time to buy a stock is a few months before Elon Musk tweets about it; the best time to sell it is the day after he tweets. If Elon Musk just sold advance notice of his tweets to hedge funds, he could be the richest person in the world. To be clear, though, this is not quite what I had in mind yesterday, since these guys got into their GameStop position long before it went nuts. I still want to read about fast-money hedge funds who had no position in GameStop until last week, and who were then like "huh, GameStop at $147.98, I think it has one more day to run" and bought the stock for no fundamental reason at all. "'Lol GME to 1000 [rocket emoji] [rocket emoji] [rocket emoji]' is a perfectly good hedge fund thesis right now," I wrote last week, and I want to read about a hedge fund that actually tried it. How'd Reddit do?Is it a widely held stereotype that high school health education teachers all do a ton of drugs, and that they are secretly winking when they tell their students to just say no? It was at my high school. Anyway here is the funniest possible detail about the face of the Reddit GameStop revolution: Moonlighting under the name Roaring Kitty, Keith Gill became something of an online folk hero for his dedication to GameStop, the struggling video-game retailer at the center of a trading frenzy that sent its share price into the stratosphere. But now a regulator in Massachusetts wants to know more about Mr. Gill, a registered securities broker, and his former day job as a financial wellness education director at an insurance company based in Boston. Inspired in part by Mr. Gill's cheerleading, thousands of small investors pushed stock in GameStop to as high as $483 a share and made Mr. Gill fabulously rich on paper. A picture he posted last week on the Reddit WallStreetBets forum showed his GameStop investment was worth $48 million, though his actual returns could not be independently verified. But Mr. Gill's former employer, MassMutual, has told securities regulators in Massachusetts that it was unaware that Mr. Gill had spent more than a year posting about GameStop on social media, online message boards and YouTube. The insurer also told regulators that had it known about Mr. Gill's outside activities, it would have asked him to stop or possibly fired him. … The Massachusetts regulator is investigating whether Mr. Gill or MassMutual broke any rules.
We have talked before about how Gill worked at MassMutual, but "financial wellness education"? After a long hard day of financial wellness education, Gill went home and engaged in some extreme financial illness to blow off steam. I am desperate to know if it leaked into his job. Like in the last week that he worked at MassMutual—which was apparently last week???[2]—I like to imagine that he showed up on Monday morning in a suit and told his financial-wellness classes "make sure to buy lots of low-fee index funds and pay down your highest-interest credit cards first," and by Friday he was in a headband and sunglasses, unshaven and smoking two cigarettes, telling his classes "look the reality is that drugs are great, the only way to feel anything in life is by putting all your money in out-of-the-money GameStop calls, YOLO, wellness is an illusion." The basic dumb contours of the GameStop trade are becoming increasingly clear: - People on Reddit who got into it early, like Gill, have made small or occasionally biggish fortunes.
- Hedge funds who were long early, like Senvest, and hedge funds who were short late, like Mudrick Capital Management, have made large fortunes.
- Hedge funds who were short early, like Melvin Capital, have lost large fortunes.
- Intermediaries—high-frequency traders, options market makers, brokerages—have been a bit cagey about how they're doing, and have had a stressful couple of weeks, but there is a widespread sense that they mostly made a lot of money.
- The financial system will survive just fine thank you.
- People on Reddit who got into it late have lost—well, most of the money they put in, anyway. One hopes that was mostly fun gambling money, because by the time they got in this was incredibly transparently stupid and they had to know they'd lose everything, but of course one worries. There are already stories about people losing more money than they could afford to risk, and there will be more, and that will make people angry.
Those are really the basic dumb contours of a pump-and-dump scheme. I don't actually think that GameStop was a pump-and-dump scheme in any real sense. I think it was some combination of (1) genuine, somewhat fundamentally motivated (and somewhat nostalgia-motivated, somewhat anti-short-seller-motivated, etc.) enthusiasm for the stock on Reddit, (2) an "honest pump," in which everyone cheerfully played a game of pushing up the price and hoping they wouldn't be left holding the bag, but knew what they were doing, and (3) Reddit posters discovering, accurately describing, and then all jumping in independently to make legal use of some of the weird mechanisms of the stock market to drive a price up. Some of those mechanisms were "short squeezes" and "gamma squeezes," but the main one is that Reddit correctly noticed that if everyone buys a stock then it will go up, and then they all did that. I am not sure that there is a word, or a concept, for that. Ordinarily the way markets work is that some people want a stock and others don't and they trade it around until it reflects a sort of distributed consensus of what everyone thinks about its value. Occasionally the way markets work is that one person with a ton of money really wants a stock, or really wants it to go up, so she pays a ton of money to buy a lot of it and push around the price. (This may or may not be illegal, depending on context and her motives.) There are distributed phenomena in markets (prices reflect everyone's private information and differing views), and there are intentional phenomena (prices sometimes reflect a big whale trader moving markets), but the novelty here seems to be a distributed intentional phenomenon. Thousands of people talked it over and decided that they'd like it if the price of a stock were higher, so they made it higher.[3] Anyway, a few people made a lot of money, a lot of people lost some money, and undoubtedly a few sympathetic confused people will have lost a lot of money. That cries out for a regulatory response; Somebody Has To Get In Trouble over all of this. But I am not sure that anyone actually did anything illegal, especially not anything that was both (1) illegal and (2) central to what went on. If someone on Reddit was publishing dozens of posts lying about GameStop's sales figures and game-company partnerships, sure, that's a pump-and-dump. But in fact what seems to have happened is that hundreds of people on Reddit were publishing thousands of posts saying "HOLD!" What do you do with that? Well, the SEC is going to have a look: U.S. Securities and Exchange Commission investigators are combing social media and message board posts for signs that fraud played a role in dizzying stock swings for GameStop Corp., AMC Entertainment Holdings Inc. and other companies, according to people familiar with the matter. The scrutiny is being done in tandem with a review of trading data to assess whether such posts were part of a manipulative effort to drive up share prices, said the people, who requested anonymity because the review isn't public. The regulator is specifically on the hunt for misinformation meant to improperly tilt the market, the people said.
But I think mostly the answer is that there will be a focus on irrelevancies, a sort of "we have to do something, this is something" approach. "Capitol Hill chatter on possible post @RobinhoodApp - @reddit stock-trading frenzy legislation includes curbs on so-called payment for order flow and short selling," tweeted Charlie Gasparino, and why not, those are all words that people said about the GameStop trade, so it stands to reason that the legislative response should also use those words. "Robinhood Says Stock Settlement Times Are a Wall Street Risk," sure, the problem here is T+2 settlement. Or William Galvin is going to go after Roaring Kitty, and poor MassMutual, because they are readily available targets. This whole problem could have been averted if we had stricter rules about life insurance companies monitoring the outside online activities of their financial wellness education directors, why not. How's GameStop doing?GameStop Corp. (GME) common stock closed yesterday at $92.41, up 2.7%, on volume of 42.7 million shares, its lightest day, and smallest percentage move, in two weeks. "What is this, $SPY?" scoffed Bloomberg's Katie Greifeld. On Monday, when GameStop opened at $316.56, I pondered the weird possibility that GameStop would just stay a $300 stock forever, for no real reason except that people kept paying $300 for it. That doesn't seem especially likely today, though, to be fair, it didn't seem especially likely on Monday either. What if it stays a $90 stock, though? That's still up more than 400% from where it was a month ago. At 11 a.m. today it was trading in the low $70s. Still up 300%, etc. Another stock that I like to check in on from time to time is Signal Advance Inc. As of Jan. 6, 2021, Signal Advance was trading at $0.59 per share. Average daily volume over the previous six months was a bit less than 6,000 shares per day, worth about $2,300 per day on average. Signal Advance's most recent financial statements are from 2016, when it reported a net loss of $180,213 on zero revenue. It was not a particularly hot stock. On the morning of Jan. 7, Elon Musk tweeted "Use Signal." He was talking about the encrypted messaging app Signal, which has nothing to do with Signal Advance. The stock of Signal Advance nonetheless shot up, closing at $3.76 that day on volume of 273,998 shares. We talked about it the next day, Jan. 8, and I pointed out that it was the wrong company. The stock closed that day at $7.19 on volume of 874,950 shares. Over the weekend, more news reports pointed out it was the wrong company, and on Monday, Jan. 11, it closed at $38.70, on volume of 2.3 million shares.[4] On Jan. 13, I wrote about it again, suggesting that it couldn't really be a case of mistaken identity anymore: People just wanted to trade the wrong Signal because it was funny, or because they had an intriguing gambling game going with each other. Signal Advance closed yesterday at $3.00 per share, up more than 400% since Musk's tweet, on volume of 696,398 shares. Over the roughly four weeks since Musk's tweet, it has traded an average of 747,520 shares per day, worth on average almost $6.3 million. The latest corporate news out of Signal Advance is still from 2016. The stock has been going mostly down, sure. But you might have expected that four weeks after the brief confusion of Musk's tweet, it would go back to being a sleepy penny stock. It hasn't quite. How good are Robinhood traders?Here is a timely paper titled "Zero-Commission Individual Investors, High Frequency Traders, and Stock Market Quality" by Gregory Eaton, Clifton Green, Brian Roseman and Yanbin Wu: Contrasting with recent evidence that retail traders are informed, we find that Robinhood ownership changes are unrelated with future returns, suggesting that zero-commission investors behave as noise traders. We exploit Robinhood platform outages to identify the causal effects of commission-free traders on financial markets. Exogenous negative shocks to Robinhood participation are associated with increased market liquidity and lower return volatility among stocks favored by Robinhood investors, as proxied by WallStreetBets mentions. Platform outages are also associated with reduced high frequency trader (HFT) activity, indicative of payments for order flow. However, outages have the strongest effect on stocks neglected by HFTs, suggesting that zero-commission traders have direct negative effects on market quality.
The funniest thing about this paper is its methodology. Robinhood is both big and buggy enough to supply its own natural experiments on retail trading: If its app crashes a lot, and if those crashes are due to general mild incompetence and not correlated to any particular market conditions, then you can compare "market conditions when Robinhood is turned on" and "market conditions when Robinhood is turned off" to isolate the effect of Robinhood traders on the stock market. So: Our approach for isolating the effects of zero-commission investors on market quality relies on trading platform outages. Robinhood has experienced periodic infrastructure instability (e.g. Smith, 2020). Although lengthy delays are rare, DownDetector.com, a web platform that compiles user complaints, reports events on 25 separate trading days during our eight-month sample period in which at least 200 Robinhood users report outages. The median length of the outages in our sample is 30 minutes.
Also useful is the correlation with WallStreetBets: Analyzing the market effects of Robinhood platform outages requires a forecast of which stocks Robinhood investors would have traded in the absence of the outage. Our main proxy relies on message board activity from the Reddit WallStreetBets forum (r/wallstreetbets), which has "become synonymous with retail zeal in the pandemic age" (Kochkodin, 2021). We also consider measures of lagged Robinhood trading activity to proxy for expected trading during outages. We confirm that mentions on WallStreetBets as well as lagged ownership changes strongly predict future changes in Robinhood ownership in general, and we explore the effects of platform outages on stocks with expected Robinhood trading. … We find that stocks favored by Robinhood investors experience significantly lower trading intensity and volume during platform outages. For example, using WallStreetBets mentions as the proxy for Robinhood-favored stocks, and controlling for firm and day fixed effects, we find outages are associated with 6.2% fewer trades.
They find that more Robinhood/Reddit trading leads to more volatility: Robinhood outages are also associated with lower return volatility. Specifically, we calculate volatility using transaction price changes during five-minute windows, and we find that volatility is significantly lower among Robinhood stocks during platform outages.
They also find that Robinhood traders make liquidity worse. Assuming—as they do—that Robinhood traders are "noise traders" without a lot of fundamental information, you might expect them to make liquidity better, for reasons we have discussed a few times. If you're a market maker, you don't want to be on the other side of a big informed trader, so a market full of uninformed traders should be more appealing and allow for tighter spreads. But it could go either way: An influx of noise traders could potentially enhance or harm stock market liquidity. In canonical adverse selection microstructure models such as Glosten and Milgrom (1985) and Kyle (1985), an increase in noise trading reduces the likelihood that market makers face informed traders, which should lead to improved market liquidity. On the other hand, inventory risk models such as Ho and Stoll (1981) and Grossman and Miller (1988) emphasize that market makers are concerned about fluctuations in their inventory's value, which may be magnified by noise trading shocks. In this setting, an increase in noise trading may result in reduced liquidity.
In fact, Robinhood traders are bad for liquidity: We analyze several measures of market quality: quoted spreads, effective spreads, realized spreads, and price impact. For each liquidity measure, we find robust evidence that Robinhood platform outages are associated with improved market quality among stocks favored by Robinhood investors, with no differences for the pseudo-outages. For example, using the WallStreetBets proxy for Robinhood stocks, we find that outages are associated with price impacts that are 5.1 basis points lower, relative to a mean of 61 basis points.
If you've watched the last week or two of meme-stock trading I suppose this is intuitive. Stocks have gone up and down a ton for no reason; of course it is more expensive to buy and sell them.[5] Elsewhere in timely research, here is a forthcoming Journal of Financial Economics paper on "Hedging Demand and Market Intraday Momentum," by Guido Baltussen, Zhi Da, Sten Lammers and Martin Martens (summarized and explained here by Elisabetta Basilico of Alpha Architect): Hedging short gamma exposure requires trading in the direction of price movements, thereby creating price momentum. Using intraday returns on over 60 futures on equities, bonds, commodities, and currencies between 1974 and 2020, we document strong "market intraday momentum" everywhere. The return during the last 30 minutes before the market close is positively predicted by the return during the rest of the day (from the previous market close to the last 30 minutes). The predictive power is economically and statistically highly significant and reverts over the next few days. We provide novel evidence that links market intraday momentum to the gamma hedging demand from market participants such as market makers of options and leveraged ETFs.
It is a bit of empirical support for the "gamma squeeze" theory popular on WallStreetBets: If everyone goes out and buys a ton of call options, then options market makers will have to hedge those options (by buying stock), and they will have to adjust those hedges (by buying or selling stock) as the stock price moves. They have what is called "negative gamma": They have to adjust their hedges by buying more stock as it goes up, or by selling some stock as it goes down. This increases intraday momentum: On days when dealers have a lot of negative gamma exposure, if markets go down in the morning they go down some more in the afternoon (as options dealers sell), and if they go up in the morning they go up more in the afternoon (as options dealers buy). In a meme stock like GameStop Corp., where a lot of redditors own a lot of call options (and keep buying more), the dealers' gamma exposure pushes the stock up more on days when it's up, but also pushes it down more on days when it's down. It oversimplifies to say "if you buy a lot of call options in the morning, the stock will go up all afternoon," but that was WallStreetBets' basic intuition, and for a while it was not wrong. Things happenThe Shocking Meltdown of Ample Hills — Brooklyn's Hottest Ice Cream Company. Hedge fund manager pleads guilty in Neiman Marcus bankruptcy case. Libor Convict Tom Hayes Says Inmates, Traders Both Seek Instant Gratification. McKinsey fires investment bank researchers after policy breaches. The GameStop Rally Exposed the Perils of 'Meme Populism.' 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] They owned about 3.6 million shares; if they bought them at $10 each and cleared a $700 million profit—both numbers very approximate—then that implies an average sale price of about $180. So not literally the top tick. (GameStop's highest closing price was $347.51, on Jan. 27; its highest trade was $483 on the morning of Jan. 28.) But to sell *five percent of the company* at that price—well above the highest price at which it ever traded in its history, except for four days—is pretty incredible. [2] "Mr. Gill gave his notice on Jan. 21 but was technically still an employee of the firm and its securities and investment advisory arm, MML Investors Services, through Jan. 28." [3] I don't really endorse Eliezer Yudkowsky's description of the trade, short squeezes, the endgame, etc., but he does get at this point: "But so far as I know," he writes, "this scheme has never before been successfully carried out by a large group of retail investors instead of a hedge fund. And there's a fundamental reason for that! A group of retail investors face a technically interesting coordination problem in trying to engineer a short squeeze, a problem that one monolithic hedge fund does not face. So I will be really interested if /r/WallStreetBets pulls it off successfully, or even mostly successfully. That's the part that would be front-page news on my home planet: 'Group of unprecedented size daringly challenges a never-before-solved difficult coordination problem, with billions of dollars at stake! They've made huge progress, but their critical difficulty is still to come!'" [4] Yes I realize that this undermines my advice above about selling the day after he tweets. Nothing here is ever investing advice. [5] Incidentally "noisy Robinhood traders are bad for liquidity" is not quite the same thing as "noisy Robinhood traders are bad for market makers." If they increase volatility then market makers can *charge more* for liquidity (since it is in higher demand), which shows up in the data as worse liquidity (wider spreads, etc.), but which also makes more money for the market makers—and if they are uninformed there is no adverse selection and the market makers get to keep more of the money. | 
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