Retail Traders Inflict Pain On Hedge Funds

Last week investors were reintroduced to the terminology of  'short squeeze' and 'gamma squeeze'. It has been some time since the phrase gamma squeeze was bantered about as much as it was last week as the volatility in a few stocks captured headlines. Stocks like GameStop (GME) and the movie chain AMC Holdings (AMC) saw their stock prices swing widely, but mostly to the upside. So what is going on with a few stocks like this.

 


Let me first note the type of trading activity occurring in these stocks is akin to gambling, it is highly risky and the odds are stacked against investors that are getting involved at this point in time. What took place last week were participants in an online Reddit forum, WallStreetBets (WSB), promoted purchasing the same stocks, GME and AMC to highlight a couple of the stocks. The forum members focused on these holdings, and I am going to focus on GME, as they uncovered the fact hedge funds had heavily shorted GME in anticipation that the stock price would fall. In particular, Melvin Capital had a large GME short position. Sunday's Wall Street Journal highlighted the impact to Melvin Capital in an article titled, Melvin Capital Lost 53% in January, Hurt by GameStop and Other Bets ($$).

When an investor shorts a stock they sell it at its current market price with the intent of buying the stock back at a lower price. In other words it is a bet that the stock is going down. To sell the shares short, one needs to borrow them from an investor that holds the shares. Additionally, the percentage shorted in GME was greater than 100% of the stock's float. When the short transaction is reversed, the short seller buys back the shares, returns them to the lending shareholder or institution along with a fee representing the cost to borrow the shares.

What was also occurring were investors, many driven by the discussions on WSB's forum, began purchasing the stock. Additionally, WSB investors and others bought call options on the stock, lets say out of the money (OTM) calls. An OTM call option means the strike price was higher than the underlying stock's price. If one owns a call option, it gives the owner of the call the right to purchase the stock at a certain exercise price.

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Disclaimer: The information and content should not be construed as a recommendation to invest or trade in any type of security. Neither the information nor any opinion expressed constitutes a ...

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Dragan 4 weeks ago Member's comment

Yes we have, and will continue to do so this week.