My Thoughts on GameStop

I think most of us understand the general story behind GameStop (GME). The stock spent almost all of 2020 trading under $20 and generally under $10. Investors via Reddit's WallStreetBets noticed that the stock was heavily shorted. They went long on the stock and some hedge funds that were short took a beating. The hedge fund that has drawn the most attention seems to be Melvin Capital Management. Now many of the retail investors who went long on the stock did their trades via Robinhood. For a couple days there, Robinhood put restrictions on the stock (they weren't the only ones), which drew theories that Robinhood was doing so based on a request of Citadel. Citadel and with Point72 provided Melvin Capital with $3 billion in funding and Citadel also does business with Robinhood. GameStop stock price eventually hit $483 before crashing dramatically from those highs.

Now I like anyone who follows Wall Street found this fascinating. Individual investors were teaching a handful of hedge funds a lesson. To me, it was like going to a race track, studying the horses in a race, and realizing that there was a good change that a 15-1 horse would actually win the race. The horse comes in and I get to feel like I outsmarted most every. Yet, even though I win, other betters lose. 

Then I started to read Facebook posts like the following that made it seem like the Robinhood investors were heroes of some sort. 

Original Source Unknown

These type of posts sounded like PR releases for Robinhood traders. The posts went into great detail regarding the process by which hedge funds short a stock. But when it came to Robinhood, there was the simple explanation that they were just buying the stock. That just seemed contrary to everything that I was reading about in the financial press, which was that call options were driving the stock up. Saying people were buying the stock took away the fact that this was at least partially driven by folks playing the derivatives market. Explaining the situation with this detail would make the retail investors appear less heroic. Also, I am assuming the hedge fund being discussed is Melvin Capital, which didn't go bankrupt, but instead got a capital infusion. This perhaps small lie makes retail investors look even larger than real life.

I'm not a fan of Michael Hiltzik of the LA Times. I think his liberal stance is a reason why California is in such a mess, but he provides the perfect write-up on Feb 1st regarding the GameStop situation.

Were Robinhood investors just buying the stock?

During January, GameStop shares soared nearly 2,500%, from $18.83 to $483, before pulling back.

The rise was turbocharged by purchases of call options, which allow the buyer to acquire shares at a set price at a point in the future, but don’t require as much capital per share as actual share-buying.

Did Robinhood shut down trading based on a request from Citadel? 

Now, I'll admit that my default position was that this was the reason, especially after the CEO of Robinhood went on CNBC and Bloomberg and couldn't even properly explain why the company put restrictions on GameStop and other corporation stocks that followed on the coattails of GameStop. The fact that he couldn't properly explain the situation has me thinking that he isn't the correct CEO for Robinhood.

Anyways, this is what Hiltzik has to say about the situation. 

When GameStop and other Reddit-fueled stocks took off, the brokers were ordered by Wall Street clearing firms, which sit at the top of the order-execution pyramid, to post tens of millions of dollars more in capital to guarantee those trades. Those capital rules, incidentally, were put in place by regulators in an effort to avert a repeat of the 2008 crash, which really hurt the little guy.

Robinhood didn’t have that money in hand, and to keep from failing, it had to clamp down on the trades.

Hmm, not a Wall Street request, but a Washington DC restriction took the wind out of the trade.

My Opinion

I think that we're going to find out that a handful of sophisticated investors were able to set up a "Ponzi" like scheme or perhaps we can call them the "Pied Piper" or maybe those who followed them we can just call "lemmings." Now they did their research. They came to the right conclusions. They probably have Wall Street backgrounds or have a long history of trading. And most importantly, they got a lot of people to follow their lead. Maybe intentionally or just simply unplanned, the public viewed them as the retail investors taking it to evil Wall Street.

My bet is that maybe 1% of those who invested in GME are sophisticated investors. These investors walked off with $100,000s or $1 millions in profits.

I'm going to also assume that those who jumped in early (say 49%) are walking off with profits between a few hundred dollars and $10,000s.

Then we're going to see that 50% lost money that they can't afford to lose. If I am correct, this is what gets lost in the current narrative of retail investors taking on Wall Street. These individuals got manipulated into taking risky bets by other retail investors, not Wall Street. 

Do I want to put restrictions on future such investment strategies / schemes? No. I think people have the right to do stupid things with their money. Sometimes people gamble way too much money in Las Vegas. But I do believe the current narrative around this fight is just wrong.