How does this wild GameStop saga end? Ghosts of past trade disasters offer clues
Champions of GameStop’s meteoric rise in shares describes it as a long-standing victory for family investors over nefarious Wall Street institutions, but some seasoned market watchers see parallels to past trade disasters that have ended up keeping the same. people in their pockets.
Richard Smith, chief executive of the Foundation for the Study of Cycles, compared the rise in GameStop shares, as well as other sharply shortened stocks targeted by an army of individual investors via forums like Reddit’s WallStreetBets, to, if this is done, market bubbles to materialize quickly.
At some point, the pool of buyers will be depleted, he and other market watchers warn, and stock prices that have risen solely because of trade flows could collapse.
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The obvious parallel is the dot-com bubble of the late ’90s. As in this episode, “Too many companies are making too much money building and promoting speculative surpluses by the public,” Smith said during a telephone interview. “I don’t think it will go well and I fear a whole generation of investors may get lost in the financial markets.”
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In this case, the companies that favor speculative surplus are the online brokers and market makers who have improved trading and liquidity, by getting the “user-product” model of Silicon Valley to implement it.
GameStop Corp. GME,
Shares rose just under $ 200, or 135%, on Wednesday to end at $ 347.51. Stocks have more than quintupled so far this week. They ended up at $ 18.84 last year. The shares in other companies have been reduced considerably, notably the movie chain AMC Entertainment Holdings Inc. AMC,
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The spike also increased on Wednesday as Reddit users scrambled to create additional short bruises.
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A small tightening is nothing new when professional investors try to force short sellers to buy back stocks to cover losses, accelerate profits, and create a feedback loop. What’s unique this time around is the way individual investors have come together through Reddit and other forums to fight short sellers.
The increase was driven by individual investors, many of whom bought out-of-the-money call options to raise the stock price. Market makers who sell calls to individual investors must buy underlying stocks to hedge their exposure. The strong rally mistakenly captured the short sellers, forcing them to buy back stocks at a loss, which appeared to accelerate the rally.
Watch: How the options trading craze is boosting stocks and raising market bubble fears
One of those short sellers, Melvin Capital, was effectively eliminated earlier this week and required an injection of nearly $ 3 billion from hedge funds Citadel and Point72 Capital. Melvin Capital’s Gabe Plotkin told CNBC on Wednesday that the company’s short position closed last afternoon after a large loss.
Andrew LeHeaven32 of short seller Citron Research, in a video posted to YouTube on Wednesday, also said he covered most of Citron’s short position on GameStop in the $ 90 price bracket.
The GameStop phenomenon and its reliance on the option activities of individual investors can also be seen as the latest chapter in a story in which supposedly sophisticated derivatives and financial strategies are devastating markets.
In a Twitter thread, quantitative finance pioneer Emanuel Derman told this story, starting with the proliferation of portfolio “insurances” in the 1980s, developed by finance professionals using the pricing model. Black options. This dynamic portfolio “hedge” was responsible for the intensification of the stock market crash in October 1987.
In the 2000s, credit default swaps made it easier to negotiate credit for the less demanding segments of the financial profession, thus contributing to the financial crisis, he said. More recently, options and futures have been based on the Cboe or VIX VIX volatility index
“And the notion of a volatility goal for protection made it easier for relative fans to also trade volatility that was once a professional skill,” he said.
Investors who bet aggressively on a long period of market calm saw a big payout in February 2018 when the VIX soared, forcing short bets based on volatility and blowing up some popular trading instruments.
“This is all part of the trend to use derivatives that seem to make it easier to do difficult things, which is okay when some people do it, but fails when everyone else does,” Derman wrote.