GameStop mania reveals power shift on Wall Street
The power dynamics are shifting on Wall Street. Newbie chatroom investors are winning big, at least for now, and relishing it.
The power dynamics are shifting on Wall Street. Individual investors are winning big—at least for now—and relishing it.
An eye-popping rally in shares of companies that were once left for dead including GameStop Corp, AMC Entertainment Holdings and BlackBerry has up-ended the natural order between hedge-fund investors and those trying their hand at trading from their sofas.
While the individuals are rejoicing at new-found riches, the pros are reeling from their losses.
Long-held strategies such as evaluating company fundamentals have gone out the window in favour of momentum.
War has broken out between professionals losing billions and the individual investors jeering at them on social media. Meanwhile, the frenzy of activity is stirring regulatory and legal concerns.
The newbie investors are gathering on platforms like Reddit, Discord, Facebook and Twitter. They are encouraging each other to pile into stocks, bragging about their gains and, at times, intentionally banding together to intensify losses among professional traders, who protest that social-media hordes are conspiring to move stock prices.
“I didn’t realise it was this cultlike,” said short seller Andrew Left of Citron Research, who has become a particular target of some investors on social media. “It’s just a get-rich-quick scheme.”
GameStop, AMC and BlackBerry have received hundreds of thousands of mentions across social media since early January and have vaulted into the ranks of the most traded stocks in the US market.
The mammoth gains have forced money managers to dump bets that the stocks would fall, magnifying the rally. Bearish investors who took short positions have lost $US9.3bn this year on GameStop alone, according to financial analytics company S3 Partners, including a $US5 billion loss Tuesday when the stock jumped 93 per cent to $US147.98, a new high, and extended gains for the month to 685 per cent.
On Wednesday, GameStop shares jumped to a high of $US380, briefly giving the video game retailer a market value of $US26.5bn – more than that of Delta Air Lines.
Sam Daftarian, a 44-year-old recent law school student, said he previously considered stock trading reserved for pros sitting in skyscrapers in big cities but started trading during last year’s market crash.
Among his recent winners: the embattled movie-theatre chain AMC, which soared 26 per cent Monday, recording one of its biggest moves in history. After buying more than $US1,000 worth of the shares last year – as the stock price hovered around $US4 – he was recently on track to more than double a small options bet on the company, which has been fighting to ward off bankruptcy.
He said if he had realised how lucrative trading could be, he wouldn’t have sprung for his online law or undergraduate degree.
“Please tell the wolf of Wall Street that the pigeon of San Francisco is gonna eat your lunch,” he said Tuesday, as AMC jumped an additional 12 per cent.
Individual investors have often been on the losing side of big bets. They faced billions of dollars in losses when oil prices unexpectedly tumbled below zero last year, while market veterans prospered. Trading marketed as “free” to individual traders on retail brokerages can be far from it. They have been burned by risky, leveraged stockmarket funds devised by bankers and other professionals.
Noah Williams, a 36-year-old Atlanta resident, says he has earned close to $US150,000 from his GameStop options positions over the past two weeks – yielding him enough money to pay off his more than $US43,500 of outstanding student loan debt. He currently holds about 1,100 shares of GameStop after starting to buy shares at $US16 in the fall. He has since purchased more using the leftover profits from his options positions.
“I think the big takeaway is, fundamentals do not apply to retail traders,” said Mr Williams. “It’s all about sentiment. The only reason why Tesla is worth what it is is because people believe in that company.”
Mr Williams recently updated his LinkedIn profile to include a job as a “Short Squeeze Astronaut,” a reference to Reddit’s popular WallStreetBets forum, where traders regularly boast that stocks such as GameStop are going “to the moon,” alongside rocket ship emojis.
He said he doesn’t plan to sell his shares until GameStop’s share price hits $US1,000.
The demand among individual investors has overwhelmed online brokerages, with companies including Fidelity Investments and Vanguard Group experiencing slowness or other technical glitches. Some brokerages, including Charles Schwab & Co, TD Ameritrade Holding and Robinhood Markets have also been increasing margin requirements – or the amount that investors can borrow to execute trades – for GameStop, a move typically done when volatility or risk for a security changes.
Securities and Exchange Commission staff is likely looking into the trading activity and messages on Reddit, said Brad Bennett, a former enforcement chief at the Financial Industry Regulatory Authority. Proving any type of fraud, such as market manipulation, would require showing that traders conveyed false or misleading information to goose the stock price, he said. An SEC spokesman declined to comment.
“If it is just folks whipping each other into a frenzy on the internet, it is hard to find a violation,” Mr. Bennett said.
“But if you have people putting information out on a website, and these are stock pickers selling into the frenzy and they are not disclosing that, it can be fraud.”
The sharp run-up in GameStop and AMC shares comes amid a period of relative calm in the broader stock market. The S&P 500 has slipped about 1.7 per cent this week, leaving it roughly flat for the year. That compares with week-to-date gains of 417 per cent for GameStop and 172 per cent for AMC.
AMC has been the most actively traded stock in the entire market in recent sessions, replacing Apple, a behemoth more than 1,400 times its size. Speculative options trading on GameStop and AMC has grown to the highest level ever, leaving traders ogling at the dramatic price moves on their screens.
Pinpointing the origins of the GameStop frenzy is difficult, but signs of individual investor interest began to emerge in earnest in 2019 on Reddit forums. At the time, some users began posting screenshots of bullish options positions and debating why the stock could rise.
That same year, one Reddit user posted in March that the company was a “deep-value play.” Another Reddit user noted at the time that Michael Burry, the investor who famously bet against mortgage securities before the late-2000s financial crisis, had built a stake in the company through his investment firm Scion Asset Management LLC.
Mr Burry “is trying to start an epic short squeeze,” one user posted on an investing Reddit forum in August 2019, a reference to a phenomenon that occurs when a stock’s price begins rising, forcing bearish investors to buy back shares that they had sold short to curb their losses.
By 2020, chatter about a possible short squeeze had moved beyond just a working theory among a few users. Post after post noted the elevated short interest in GameStock stop, with one user in April 2020 predicting it would be the “biggest short squeeze of your entire life.” Even more, many users predicted, new consoles including the PlayStation 5 were coming in late 2020. That alone, they thought, could help lift the share price of the struggling video game retailer that had already begun closing stores around the globe.
By early January, GameStop had moved from a stock recommendation to a phenomenon. GameStop was no longer only an opportunity for a big payday or a way to back a struggling company. Buying GameStop for some users had turned into a way to confront institutional money. Users encouraged others to hold the line: “Do not sell.”
Big losses
The soaring stock prices of heavily shorted stocks have ensnared some of Wall Street’s best traders. Top-performing hedge fund Melvin Capital Management, which managed $US12.5bn at the start of the year, had lost nearly 30 per cent for the year through Friday due largely to its array of bets against companies including GameStop, said people familiar with the fund.
With losses mounting, Melvin founder Gabe Plotkin orchestrated an emergency deal Monday in which Citadel LLC, its partners and Point72 Asset Management would immediately invest $2.75bn into Melvin’s fund to help stabilise it.
As part of the deal, they got non-controlling revenue shares in Melvin for three years. The move effectively reduced Melvin’s reliance on borrowed money and, therefore, the likelihood of margin calls from Melvin’s prime brokers.
Melvin’s put options – bearish contracts that typically profit as stocks fall – against GameStop expired in mid-January and it closed out its shorts Tuesday. “Melvin Capital has repositioned our portfolio over the past few days,” a spokesman said in a written statement. He declined to comment on how much of Melvin’s losses came from GameStop.
Maplelane Capital, a New York hedge fund that started the year with about $US3.5bn, was down roughly 30 per cent for the year through Wednesday, with its bearish GameStop position a significant driver of losses, said people familiar with the firm. One of the people said the fund has adjusted its portfolio over the past two weeks to preserve capital.
The steep drawdown is rare for Maplelane, started in 2010 by former Galleon Group trader Leon Shaulov. Maplelane has returned an average 29.4 per cent a year since its inception, according to an investor document.
Covering
Some traders said they had been covering their shorts on other stocks like Palantir Technologies and Stitch Fix because they worried those companies could be the next GameStop.
Others have been forced out as stocks like GameStop and AMC soar, triggering their firms’ limits on the amount of risk a portfolio manager can take. Hedge funds reduced their exposure to stocks, by trimming their bullish positions and covering bearish ones, on Monday at the sharpest clip since August 2019, according to Goldman Sachs Group.
Meanwhile, chatter about “Melvin” has been dominant on Reddit, according to an analysis by Meltwater, a global media intelligence company, with more than 40,000 posts tied to the firm circulating over the past month. One post gloated: “We are better at being irrational than Melvin is at being solvent.”
Individual investors are aware of their growing clout, and know when to deploy it.
On January 19, a Twitter account identifying itself as moderators for WallStreetBets posted that the forum had long been dismissed, but “we are also now a powerful force to be taken seriously.”
Some users have expressed concern that the SEC would act if users appeared organised. On Discord, in a chat room linked to WallStreetBets, a user on Tuesday posted, “Guys, we need to pump $GME. Everyone buy 1000 shares in exactly 60 seconds”
Some on WallStreetBets have targeted Mr Left of Citron Research, who made his bearish position on the company public. He said he has been trolled by throngs of people on the internet, including many who he said harassed family members, including his children. Many people ridiculed him as a “boomer,” he said.
His announcement served as a cue for hordes of other investors to pile into the stock.
“When Citron got involved, that’s when I think I wanted more involvement, “ said Danny Faiella, a 33-year-old house painter in Hilo, Hawaii, who trades between jobs and has poured about $US3,500 into GameStop stocks and options. He has been buying calls tied to GameStop since November – positions that rapidly jumped in value as the stock soared – and ramped up the trade after Mr Left revealed his position. “I find value in the stocks that he now shorts.”
On Wednesday, Mr Left said in a video that he closed most of his short position.
Although investors betting on and against stocks had one of their best years in more than a decade last year, they have been buffeted in recent years by monetary stimulus by central banks around the world and by the rise of passive and quantitative investing. Stock pickers say all of these forces have distorted equity markets.
Social media, they say, may be the next force with which to reckon.
GameStop’s soaring stock price and the pain it has inflicted on short sellers has raised comparisons with Volkswagen’s surge in late 2008, which dealt a blow to hedge funds around the world. The stock’s gains, fuelled partly by fellow German car maker Porsche Automobil Holding SE saying it had boosted its VW stake and planned to gain full control of VW, briefly left VW the world’s largest publicly traded corporation.
The extraordinary moves in individual stocks come as trading activity among individual investors has surged during the coronavirus pandemic, drawing investors young and old, inexperienced and seasoned. In 2020 alone, it is estimated that more than 10 million new trading accounts were created, according to JMP Securities.
To market observers, the companies that individual investors favour don’t always make sense. In recent months, they have sent soaring shares of Hertz Global Holdings, the car-rental service that filed for bankruptcy protection last year, and Eastman Kodak, the struggling photography company. Hertz was ultimately delisted from the New York Stock Exchange and trades on the over-the-counter market, while Kodak has fallen more than 60 per cent from its 2020 high.
That has many Wall Street traders convinced that rallies like GameStop’s could ultimately fizzle, too.
Short sellers’ interest in GameStop remains high, even as the borrowing cost, or the fee that bearish investors must pay a broker to borrow shares in order to short them, has skyrocketed. The median borrow cost for stocks in the S&P 500 is 0.3 per cent.
As of Tuesday afternoon, the borrow fee for GameStop stock was around 31 per cent for existing shorts, while “quite a few” have been increased to 80 per cent, according to S3 Partners. The borrow fee for new short positions has climbed as high as 200 per cent.
Inflicting pain
The record run for stocks like GameStop comes as access to options bets has grown easier than ever, allowing investors to super-size their bullish bets and, in some cases, inflict additional pain on short sellers.
Options give investors the right to buy or sell shares at specific prices, later in time. They can be used as trading tools to wager on the direction of stocks, or to hedge portfolios. Lately, many investors have been using them to rapidly double, triple or even quadruple their money, since they can put down a relatively small sum in exchange for a giant return, albeit risking a giant loss.
They have been snapping up options on GameStop that would expire within days.
The volume of trading and the high number of outstanding, short-dated call options in GameStop has astonished Wall Street veterans. More than 2 million options contracts tied to GameStop changed hands Friday, the most on record. Options volumes for AMC hit a high on Monday.
As shares rise, dealers who have sold the calls have to buy shares to hedge their positions. These call options multiplied in value as GameStop shares surged, forcing dealers to buy more of the company’s shares to hedge their positions.
And the surging share price lured even more traders into the fray, spurring demand for the shares, creating a snowball effect. Meanwhile, systematic funds started to get involved in the stocks, helping push the stocks higher.
“It could add fuel to a short squeeze,” said Danny Kirsch, head of options at Cornerstone Macro, of the options activity.
Options volumes this year are accelerating after a record 2020. Four of the five largest volume days for call options dating back to 1973 have happened in the first few weeks of 2021, according to Trade Alert data. On January 25, more than 32 million bullish calls changed hands, making it the most active day for such bets in history.
The momentum surrounding the stock could ease and these bullish bets could quickly reverse. And all the options trading on the way up could exacerbate a downward spiral in the stock, traders said.
Calls of manipulation
The mob-like mentality on WallStreetBets has some professional investors calling foul.
Mr Burry, who drew some of the early attention to GameStop, on Tuesday posted in a now-deleted tweet: “If I put $GME on your radar, and you did well, I’m genuinely happy for you. However, what is going on now – there should be legal and regulatory repercussions. This is unnatural, insane, and dangerous.”
Many traders have been questioning whether users who have been posting about the company and urging others to buy shares and calls could be considered a “group” by the SEC’s definition. That designation could require regulatory disclosures for investors acting together on a particular stock and at certain thresholds restrict trading and require a return of some short-term profits.
Hedge funds and their clients also have been asking whether the activity could be considered market manipulation.
Moderators on Reddit investing and trading forums have disputed in posts the notion that the forum manipulates markets, and in replies to users have said they are strict on enforcing group rules, which “relate to promotions and pump and dumps,” one moderator said in a stocks subreddit this month.
“There is NO organised effort by those [of] us who moderate this community to promote, advise or recommend any stock,” another recent post on WallStreetBets said. “It is against our policy to do so and we feel it is crucial to allow members to be able to share their ideas amongst each other with autonomy.”
Securities and regulatory lawyers say neither market manipulation nor group cases, particularly in the context of anonymous internet posters, are easy ones to make. The former raises the question of whether the SEC has the will to go after individual investors or require a short seller to file suit and open up its own books for discovery, they say.
Jordan Laws, a 40-year-old video producer who worked for Bernie Sanders’ presidential campaign last year, said he considers WallStreetBets to be an equalising force among professionals and amateurs.
“The hedge funds have been doing it forever. It isn’t like they haven’t taken their guys and gone on CNBC,” said Mr Laws, adding that their comments can move markets.
He bought bullish call options tied to AMC after seeing the run-up in GameStop shares and tracking the incessant chatter on Reddit and Discord. They have ticked up in value, but he thinks there’s more room to run.
“I’m waiting for the cavalry to arrive,” he said.
-With Caitlin McCabe, Dave Michaels
-Wall Street Journal
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