Explanation of the current market manipulations

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By now, I am sure you have heard about a group of regular Joe’s who are currently causing some consternation to the giant hedge funds on wall street. They seem to be doing what the hippies in the occupy wall street movement couldn’t do. To make it all more easy to digest, my very old friend and PhD of Economics “CJ” has given us a quick break down to help it be a little more easy to understand.

A slightly technical explanation about what is going on…

Short sales
Borrow stock from person A (usually an institutional investor) with a promise to return at a fixed time in the future.
Immediately sell stock, (say for $10) then buy at a later date when the price (hopefully) falls (for example ($4), return it to person A.  Profit $6 from the difference.

Float is the % of shares that are not held by insiders (and therefore not available to be traded).
Institutional ownership is the % held by mutual funds, pension/endowment funds, hedge funds, etc.
“institutions” exercise investment discretion over assets of others
Shares short as a % of float is more relevant in this case.  

If % of shares held by institutions exceeds 100%, then one explanation could be…
Institution X holds shares
Investor Y borrows shares from institution X and sells them to institution Z.
Both institution X and Z “hold” shares for reporting purposes.
If the % of float held by institutional investors exceeds 100%, a likely explanation is that institutions have purchased borrowed shares that short sellers have sold.
Go to Yahoo Finance, search for GME.  Click on “Holders”

GME has around 70 million shares shorted with a float of around 50 million shares.  This explains why prices are swinging so wildly in this case.

When selling a stock short…

Initial margin requirements are 150% of the value of the shorted stock.  So if you sell $100 worth of stock short, you are required to have $150 in your account
$100 from selling the stock plus an additional $50.

Maintenance margin requirements
130% of the market value of the short sale.
If the market value of the stock unexpectedly rises from $100 to $200, then you need (200 x 1.3 = $260) in your account to maintain margin requirements.
You have $150.  You now need an additional $110 to maintain your position (there’s still a chance the price falls if you can just hold on a little longer).  Alternatively you could just buy back the shorted stock for $200 ($50 more than you have) to close out your position.

If prices rise, then at some point you will be forced to liquidate your position (buy at the high market price and return the shares to the broker you borrowed from).  You’re forced to sell when you don’t have enough liquidity to repurchase the shares past a certain price.  If a huge group of small investors with Robinhood apps can all converge on a particular stock at the same time, they can bid the price up, potentially forcing investors with short positions to face margin calls (which will bid the price up even further when they liquidate their short positions).

https://www.cnbc.com/2021/01/27/hedge-fund-targeted-by-reddit-board-melvin-capital-closed-out-of-gamestop-short-position-tuesday.html
(Some on the forums are saying this didn’t really happen as is being reported.)

A second factor that could lead to large purchases and a rise in the price of GME involves call options.

Call Options
The option to “call” and buy at an agreed upon price, known as the “strike price”…

If the stock price is higher than the strike price, then the call option is said to be “in the money.”  If the stock price is lower, then the call option is “out of the money,” and will ultimately be worthless if the stock price does not rise.

Call options are sold in blocks of 100.  9 months ago a user by the name of Senior_Hedgehog made the suggestion that everyone buy call options on GME far out of the money.  GME was trading at $4 per share.  One user purchased 800 call options (representing 80,000 shares) giving him the right to buy at $12/share, and the options expire in April of 2021.  He paid $250 for these.  These options were trading very cheaply at the time because nobody expected the price to triple.  On Tuesday, when GME was trading at around $150/share, these options had grown in value to $10.6 million.
Brokers selling these options have to purchase 100 shares/per option if the options are exercised.  In this case, they would have to purchase 80000 shares at whatever the market price is and then sell to this investor for $12 each.  That investor can then immediately resale them at the market price, which would net $10.6 million.
That same investor later purchased 50,000 shares for around $15/each.  Those shares had grown 10x in value by Tuesday.

It may take time to unwind these short positions but eventually the price of GME will return to something more consistent with market fundamentals.

There are rumors that other stocks are being targeted, but if you look at the % of float held by institutions, you’ll notice that a lot of these cases are very different than GME.  Also, with Robinhood and Interactive Brokers and other trading platforms delisting these targeted stocks, it becomes a lot more difficult for small traders to bid these prices up.  It is likely that the wild price swings you see with GME will be unlikely with other securities.

There have been rumors that a similar price run-up on silver is possible, but currently these do not seem to be panning out, as a 20% initial price jump in AG (a Canadian silver mining firm) and a small jump in SLV (iShares silver trust) seem to have stabilized.

2 COMMENTS

  1. A good short squeeze is always fun to watch – especially when the masters of the universe go crying to the SEC about it.

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