Despite a historic week for GME, which closed at $347 this afternoon, the notoriously shorted stock has experienced some shady activity by institutional investors over the past few weeks.
A little bit of context, a few people on Reddit recently came to the conclusion that GME was excessively shorted (one of the most shorted companies on the NYSE), and had short interest of around 140% (meaning the number of shares that have been sold short but have not yet been covered or closed out).
As a result, GME’s experienced a “Gamma Squeeze”.
When an investor buys an options contract, it is typically from a market maker whose role in the market is to provide liquidity. Market makers stand ready to buy and sell all sorts of securities with the goal of profiting off the bid/ask spread. But since options are leveraged derivatives, market makers are potentially exposed to incredible levels of risk. In order to mitigate this directional risk, market makers hedge their options positions by trading in the underlying stock.
There are different (but very important) factors on pricing options, but the two most relevant here are delta and gamma. Delta ranges from 0 to 1 and represents the expected change in the options price if the underlying stock moves by $1. At-the-money (ATM) options will tend to have a delta of around 0.50, and delta approaches 1 as the option moves deeper in-the-money (ITM). Gamma estimates the change in delta if the stock moves by $1, effectively measuring the acceleration of delta as the option gets closer to ITM. Gamma is highest for ATM options.
Another way to interpret delta is that it loosely represents how many shares of stock the option contract will behave like. Since an options contract represents 100 shares, having a call with a delta of 0.50 would be similar to owning 50 shares — either position would gain $50 if the underlying stock increased by $1.
For example, if an investor buys an ATM call contract from a market maker, that market maker is now short 1 contract and has a position of negative 0.50 delta. To hedge that risk, the market maker will typically go and purchase 50 shares of the underlying stock. If the stock continues to rise, the market maker’s delta position also becomes increasingly negative at a faster rate due to gamma, requiring more buying, which pushes the stock even higher still, and so forth. This phenomenon is known as a gamma squeeze and the feedback loop resembles a regular short squeeze.
Gamma squeezes can be particularly potent when investors are purchasing a high volume of out-of-the-money (OTM) contracts, which WSB traders are doing en masse. If the stock begins to rise to approach the strike price, that is when the delta acceleration (measured by gamma) is the strongest.
The extreme volatility we’ve been seeing is a multitude of all these factors.
However, the “big boys”, i.e. the institutional investors and firms were not going to stand by while the little guy was earning a buck.
Imagine you’re one of the big shorts on GME. You’ve been shorting this thing for years and have watched its stock price drop from $30 to $15, and even to a low of $3 in 2020. If you’re Bank of America, your analysts are telling you (and others) this thing is going to $1.
But then things get out of hand, very quickly, with GME climbing from $3 -> $20 in 9 months and then in one week doubling to $40. You were not prepared for this (now $347). It’s a disaster
What do you do? You leverage every tactic you can to drive the price down.
1) Attack retail investing capabilities:
- Bank of America owns Merrill Lynch. Merrill Lynch has a retail brokerage. Since you’re short GME, you have your risk department over at Merrill Edge increase the margin requirements on GME strongly and suddenly on all retail buyers.
- This causes a chain reaction. Brokerages generally mimic the margin changes on other brokerages, because they don’t want to be the ones where all the “risky” traders go to. So other brokerages start increasing their requirements. Pretty soon, Schwab, Fidelity, Ameritrade, IBKR have all increased their margin requirements to the point that many buyers cannot buy more shares, or if they had bought on margin, need to liquidate or provide more capital.
- Meanwhile, the big guys – banks and hedge funds that are short – use prime brokerages, and since I don’t have access to one I can’t confirm, but very much doubt had any margin changes to GME.
2) Manipulative shorting:
- On Friday (1/15) you take advantage of the fact that most call buyers on GME are not going to take assignment, so as they sell their calls which are now worth huge sums of money, Market-makers (MMs) are going to sell the shares they’re using to hedge the calls. So you short the stock as hard as you can, driving it down as low as 14% at one point, but it creates too strong of a sell-off triggering a short-sale restriction.
Great, at this point, you think you’ve killed some of the momentum going into the 3-day weekend. Hopefully investors will realize more of their mistake and sell off their foolish investment for the next Blockbuster. But then, things go awry, retail buyers are not shaken. In fact they’re enraged, and the GME movement grows more popular than ever, becoming the most mentioned ticker and even getting a stickied thread each day on WSB.
The US markets are closed on Monday. Doesn’t matter. Europe takes the mantle, driving the price up from $35 at close on Friday in the US to $40, then $44.
You’re about to get squeezed and you need to do something fast. You can’t short the price down Tuesday in US trading because of the short sale restriction, and the momentum behind GME is palpable.
So now, you must get even more agressive.
3) Orchestrated media attack & shorting:
- Here’s what you have to work with. There are at least 1.2 million shares available to short in just IBKR, and more in prime brokerages thanks to all the retail buyers buying shares in Robinhood. “Robinhood Securities earns income from lending margin securities to counterparties.” At a 54% borrow rate, that’s quite a nice return for RH for holding your shares.
- You call up a famous shorter known for impacting equity prices – Andrew Left of Citron. Offer him tons of money to put out a hit piece on Tuesday after markets open. It doesn’t matter that he doesn’t have shit prepared and you need him to do this tomorrow. He’s just going to threaten an attack to kill the momentum.
- Tuesday market opens. GME rockets up 25% to $45/share within the first few minutes. Then comes the orchestrated attack.
- Minutes before Citron’s tweet, you buy thousands of OTM puts.
- 1000 1/22 40p – 26 minutes before the tweet
- 472 2/29 20p – 24 minutes before the tweet
- 2200 1/29 30p – 11 minutes before the tweet
- 424 1/22 40p – 10 minutes before the tweet
- 449 1/22 40p – 5 minutes before the tweet
- Minutes before Citron’s tweet, you buy thousands of OTM puts.
At 9:58 a.m. eastern, here comes the tweet:
- Note the language here:
- Citron’s not revealing anything until tomorrow, when short sale restrictions are done. i.e. you better not buy today!
- Price target of $20 matching exactly the lowest strike price of the puts purchased just minutes prior.
- “I understand short interest better than you” – i.e. “the shorts are paying me and I know who they are, and why they’re shorting”
- “Poker game” – he’s calling you a sucker, while at the same time tweeting a poker bluff**.** He doesn’t actually have anything ready or substantial, but the shorts paid him off to threaten the market.
- Andrew Left fired his shot. Now comes the coordinated shorting.
- In about an hour, all 1.2 million shares in Interactive Brokers are used up.
- Probably, prior to this, shorts used the invisible shares available from brokerages like Robinhood.
- Wait, shorts can’t short on restricted days, right? Wrong.
- They can short on the ask.
- When there’s fear in the market, organic sellers lower their ask to exit their positions.
- Shorts high-frequency algos move their ask to match the lowest organic ask.
- Organic seller really needs to get rid of these shares! Citron is coming! Sees he’s now not the lowest ask, so he moves it down.
- Guess what? The algos match his ask and short at the lower price now.
- This cycle repeats as long as organic sellers reduce their asks to sell.
- While all this is happening, market makers are shorting/selling shares in response to the puts placed prior to the tweet, helping push down the price.
Congratulations. In a matter of less than an hour, GME has now dropped from $45 to $37/share – an 18% drop and an absolutely incredible reversal of momentum.
Citron didn’t even have to do shit. The next day they canceled their livestream.
Some other tactics include the Short Down Ladder (Short A will open a new short position and sell a share at $40 and short B will buy that share to cover an existing position and the open a new short at $39 and so on), or Paid Bashers (paying people to spam messages boards to create panic and insight selling. This goes way back to 2007 but trust me when I say this will only get worse)
As you can see, there are a number of dirty tricks here. It’s sophisticated, coordinated, and the odds are stacked against the retail investor.
What can you do?
Ways to trade smarter:
- Don’t sell on dips. You’re only helping the shorts. If you need to sell to take profits, sell when it’s heading up. Sell high, not low
- Save dry powder to buy on dips. Dips manufactured by shorts are buying opportunities. Take advantage of folks with paper hands to capture shares at low points. GME has incredible daily volatility. Set a low limit buy and just wait for the order to fill. Have patience when buying.
- Don’t advertise when you’re going to buy. Just buy dips. There were so many folks saying “wait for 11:30 to buy!”. Well, look what happened! Just when you thought there’d be a dip, and you were all ready to buy, there was this magical, temporary rapid price spike. Congratulations, advertised to every predatory trader out there when you all were going to buy. Double-win for them: If you fomo’d in at 41 you’re probably gonna paper hands your way out when the shorts push it back down.
- Don’t buy more than you’re willing to lose. You need to hold through the dips, and be ok with the extreme volatility. IF you put too much into this all at once, you’re going to get scared when the price goes against you.
- HOLD. There is so much upside in GME, that it doesn’t matter what price you buy now if you have patience. There are so many potential catalysts coming and if all of this dirty behavior is any evidence that shorts are scared and looking for cheap buys to get out. Don’t give up your shares for cheap. Here’s a quick list of potential catalysts that could happen at any time and any of which would spell more pain for shorts:
- Share recall for a vote on major issue
- Cohen becomes CEO
- Alan, Jim (chewy directors added to board) purchase shares (they are not limited in how many they can buy)
- Cohen could buy his remaining 7%
- New higher $ investors pile in (like we have seen this week)
- Debt upgrade
- GME’s 2021 bond is done is March, the removal of which has many restrictive covenants
- Getting to profitability and reducing debt may trigger a debt upgrade by Moody’s and unlock more institutional ownership
TAKE BACK CONTROL !
Another thing to note is weekly options expire every Friday, and shorts will be called to cover their positions. More buying pressure may be in the near future, and this time without the help from retailers.
Works cited:
https://www.reddit.com/r/wallstreetbets/comments/l1tg88/gme_how_shorts_manipulated_you_and_how_you_can_be/