Throughout the week, experts have been observing not only what is happening in the markets and especially the stocks against which hedge funds are betting, but also the media space trying to rationalize or support the Reddit community of WallStreetBets. By now, you’ve probably heard about the story with the shares of GameStop and other companies (AMC, Nokia, BlackBerry, Bed Bath & Beyond, National Beverage). You could form an initial understanding of the situation by reading this good article on vc.ru. Almost all articles unfairly and incompletely form an idea of the situation for an ordinary investor and are full of catchy headlines: – “Teens on Reddit outplayed all hedge funds, banks, financial institutions, and the rich.” – “Retail Investors – The New Power on Wall Street” “Selling short is a dishonest hedge fund strategy. Reddit has restored justice ” In this regard, Mendeleev decided to provide additional information to form a more objective picture of what is happening.
1. “Who Benefited from the Growth in GameStop Stock?”
At the outset, there are key pieces of information to share about who made the gain from the rise in casinos not part of GameStop stocks. You’ve probably seen headlines about individual retail investors or bloggers becoming dollar millionaires, hacking Wall Street, losing hedge funds, and so on. It is logical to assume that shareholders, whose shares rose in price, benefited from the growth of GameStop shares. However, the largest shareholders of GameStop are far from Reddit users, but the very rich people or large financial institutions, against which the Wall Street Bets movement is opposed. So, since the beginning of 2021, the paper profit for the co-owners of GameStop looked like this:
1) Top 10 financial investors: $ 13 billion in profit.
2) Ryan Cohen, billionaire, GameStop’s largest shareholder: $ 2.7 billion in profit.
3) Donald Foss, Michigan-based billionaire, GameStop’s largest shareholder: $ 1.1 billion in profits.
4) GameStop top managers and directors: $ 300 million in profit.
5) From the Wall Street Bets community, only a few “winners” in the lottery are known: those who posted screenshots with paper profits of $ 20-50 million.
6) Remember, though – When brokers blocked trading on Thursday, GameStop’s shares fell 60%. Since many retail traders performed transactions with a leverage of 2-3 (x) times (lending to buy shares), the positions of many people were forcibly liquidated by brokers as a result of the so-called margin call. In other words, retail investors who joined at a bad moment lost up to 100% of their invested funds in a few volatile hours. “Who was affected by the rise in stocks like GameStop?” As of January 28, according to Ortex, hedge fund losses from short positions in US equities were $ 70 billion. Whose money is it and who ultimately bears the losses?
7.) Stocks keep going up despite knowing how to bypass gamstop.
The Preqin report will show that the main providers of capital to hedge funds are public, corporate pension funds, university funds, charities, and more. There is a prejudice in the media that hedge funds are the privilege of the ultra-rich. This is not true. A significant part of their capital is issued from pension funds, which manage the savings of ordinary people.
By the way, this is pretty standard practice in North America and Europe. Accordingly, when the hedge fund loses money, the final investor of the pension fund, in the person of the middle class, also loses it. If the take-off continues (further “short squeeze”), the entire wide market may fall. This is due to the following: the trading of hedge funds works in such a way that on average they have gross positions in the amount of 2.5-3.0 times the managed capital. So, for example, you have $ 100, with which you buy ABC shares, and for another $ 100 you can “short”, say, XYZ. After two operations, under normal market dynamics, your average risk to market movements is zero (+100 – 100 = 0). According to Goldman Sachs, the current leverage of hedge funds is 260%. However, to stay with “0” risk in case of losses on some positions, you will have to sell others.
This is called “de-grossing”, which happened last week (the strongest since 2009). As a result of the gambling websites not being on the GameStop story, hedge funds were forced to sell their positions in absolutely all market sectors. Is the fall in the broad market good for the layman? In other words, if the short squeeze continues next week, hedge funds are likely to be forced to quickly sell off quality broad market stocks. This also causes short-term damage to long-term investors of any type. “Retail Investors – The New Power on Wall Street”? Some lucky ones who managed to buy short-term options at even low prices (with low implied volatility) can be called lottery winners at the moment when the EU casinos that accept UK players no deposit bonus broke down a bit, rather than with a new force.
Of course, “casinos” will be repaired, and with proper regulation and better risk management practices, these stories are no longer scalable. What happened was made possible as a result of Organizing a community of people on Reddit and widespread distribution of the Robinhood shopping application. A large number of shares sold short (~ 140% of all EU casinos that accept UK players no deposit shares were short). As of today, the reduction in positions has dropped to ~ 120%. Cheap call options with low implied volatility. The cost of options for their sellers acts as a kind of sold growth insurance. As a result of the last week, option sellers (aka “insurers”) have lost money.
No one in the “insurance business” will lose money permanently, but on the contrary, will increase the cost of insurance. All of this will lead sellers of “growth insurance” to overestimate small companies with a large share of short-listed shares and set prices on derivatives that will no longer be beneficial to speculators on Reddit. The narrow “community of smartphone trading enthusiasts” is limited by its number and a few brokers. By the way, why did brokers begin to prohibit transactions?
Broker Robinhood itself faces bankruptcy
Robinhood and other brokers have completely banned new trades and limited positions in many stocks. If there is more than one share in the portfolio, now only the liquidation of this position is possible. This is risk management. Robinhood, like other brokers, is required to have deposited at the exchange’s clearinghouse. The role of the clearing center is to ensure fair settlements between market participants. Thus, the central clearinghouse on Wall Street (Depository Trust & Clearing Corporation) obliged Robinhood to make large deposits as a result of the increased volatility.
To comply with this requirement and not lose the license (= not go bankrupt), Robinhood was forced to use its open credit lines and in a few hours to raise at least $ 500 million from a consortium of the largest banks. In addition, it had to raise equity capital from major investors. The total amount of capital provided was at least $ 1 billion. Even after these capital injections, Robinhood will not allow trading on 8 shares on Monday. It turns out that the big financial giants, which are called “evil” on Reddit, saved Robinhood, a broker for millennials, from bankruptcy. Otherwise, the newly-made millionaires could have remained only with a bankrupt broker, and instead of several million, they could receive only the maximum $ 500 thousand (the amount insured by the US government).
Thus, the hype thesis that retail investors are becoming a “new force” is far from reality. Retail investors in this situation have become just fuel for growth, taking on market risk when buying options, and the financial industry is a little more complex than just a smartphone application. Capital markets exist so that businesses and governments can raise capital, and those who have accumulated savings could place them in a diversified portfolio. If the value of assets becomes infinitely volatile, then there is a significant deviation from fair prices, the system is going through crisis moments and there is an unobvious victim that no one talks about.
What market participants expect in the future:
– In the coming week, gambling sites not linked to GameStop management will announce a significant additional issue to try to bring the business out of the crisis. This way the management will be able to attract real capital at the prices that are optimal for it. – In the long term, the shares of these companies will significantly decline to their fair price. – As a result of the scandal, trading in options may be regulated and made possible only for accredited investors, or for investors with a minimum confirmed level of equity capital (for example, $ 50 thousand). Save your money!