Weighing The Week Ahead: Does The Reddit Rebellion Threaten Investor Portfolios?

As trading in GameStop (GME) shares reached fever pitch this week, his portfolio updates appeared to encourage other investors to stay in the stock.

“Your steady hand convinced many of us to not only buy, but hold. Your example literally changed the lives of thousands of ordinary normal people,” wrote one user on Wednesday.

And also..

After online brokerages restricted trading in GME on Thursday, Gill posted that he had lost $14.8 million that day alone, but was still up $33 million overall.

That post was met with thousands of replies, with many simply repeating: “IF HE’S STILL IN, I’M STILL IN.”

The NYT has much more background about how Mr. Gill started building followers.

Will Congress get involved? Of course. This is a juicy opportunity to express concern about a matter of interest which many portray as worrisome.

The House and Senate committees that oversee the financial sector will hold hearings on the state of the stock market, giving lawmakers a chance to vent their anger and play up their anti-Wall Street credentials to constituents. The Hill.

Will any legislation result? No. This is a story about symbolism.

Are the Reddit folks engaging in something illegal? Almost certainly not. Cheering on a stock and urging others to join in is a normal practice with a long history. The difference is the reach of modern social media. Proving something like price manipulation would involve quite different actions with a clear central organization.

Is there something evil about short-selling? No. A market price for a security is the net result of investor opinions. Short positions in stocks are part of the process of price discovery. They may also be hedges against option holdings. The short seller may have an overall long position in the security.

How does this process work? Those seeking to sell short must first borrow the stock. Brokers lend shares of stock for this purpose, charging a fee. The fee is typically about 30 bps per year. For the Reddit Rebellion stocks the rate is ranging from 30% to as high as 80%. In general, you cannot sell a stock short without arranging a “borrow” in advance.

Why would investors make their stock available for lending? Most probably do not even know they have. It is a part of the brokerage agreement, definitely if you have a margin account. This is a major profit center for brokerages. That “no-fee” trading must be paid for somehow!

The short interest can be even larger than the float. Some who have secured a borrow may then lend these shares to someone else at a higher rate. Steve Sosnick, Chief Strategist at Interactive Brokers, has an excellent, detailed explanation of this phenomenon.

Do hedge fund losses represent danger to the entire financial system? No. One argument is that those with losses need to meet margin calls and may be forced to sell other holdings. This is a typical way a factual statement can be distorted. It was featured prominently on CNBC’s Friday night emergency special on this topic. Let us guess that the short seller’s losses are about $70 billion. The worldwide equity market value is over $100 trillion. Even if the entire losses had to be covered instantly, it would not require $2 trillion worth of selling, a conservative estimate of the decline in market value.

Is this like the Long Term Capital Management situation, which required a $3.625 billion bailout from big banks orchestrated by the NY Fed? No. The many differences include the following:

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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