How Reddit's Roaring Kitten earned 28.500 on GameStop promotions: simple explanation
Everyone is discussing an insanely beautiful story about how the guys from Reddit were able to defeat arrogant hedge funds, but not everyone understands what exactly happened in the markets. In this article, I explain in simple terms what exactly led to the current situation.
What Happened: Roaring Kitty Attacks!GameStop is an international video game store chain that is going through a hard time. Low profitability and unclear future prospects (who would even go to the store for something that you can just download from Steam?) Led to the fact that the company's shares fell from $ 55 in 2013 to $ 4 by mid-2020. Several large hedge funds were convinced. that the fall in GameStop stock prices will continue: as the professionals say, they "short-cut" these shares by a large amount.
Educational program: how the market worksFor the sake of simplicity, let's imagine that the stock market works in much the same way as the grocery one, and GameStop shares are like bags of potatoes that are sold on it, and let's imagine Fedor, who works in a hedge fund, and came to the market to make money. If now you can buy a bag of potatoes on the market for ₽100, and Fedor expects the price to rise in the future, then making money on this is not difficult - you just buy a potato supply and wait for the right moment to sell at a profit. But if Fedor thinks that the potatoes in fact, it is frozen and its price will fall in the future (for example, up to ₽60) - then in order to turn this idea into money, he will have to come up with something more interesting. For example, he can borrow a bag of potatoes from someone with a promise to return in a month and immediately sell it at the current price for 100 ₽. And if in a month the price really drops to RUB 60, then he will be able to buy potatoes back from the market at this price, return them according to the agreement, and the difference in the amount of RUB 40 will become his profit (well, minus the agreed interest on the loan, of course). This whole operation is called "getting short", or "shorting". So far, everything is simple. Now let's think: who could Fedor borrow a sack of potatoes? Ordinary counter-sellers are not comfortable doing this: they came to the market to sell, not engage in debt transactions. Therefore, Fedor will have to go to Boris the broker - "looking after the market." Boris is a respected person: he makes sure that all transactions on the market are carried out honestly, no one deceives anyone, and at the same time he keeps potatoes belonging to a large number of buyers and sellers in his protected cellar. So Boris can easily lend Fedor some of the available in the bins of potatoes as part of the short deal. However, Boris is gnawing at the thought: what if Fedor drinks the proceeds from the sale of borrowed potatoes? Why would he then buy a sack of potatoes to return to Boris? The risk is serious: after all, if Boris the broker does not receive the owed from the debtor in time, he will have to answer personally to the ultimate owner of the root crop (otherwise the authority will end). In order not to get into such an unpleasant situation, Boris says to Fedor: “Brother, come on - I'll I lend a bag of potatoes for a while, and even help sell. But let me keep the money from the sale too - just in case. And also give me at least $ 20 of your own for safekeeping - otherwise the times are turbulent, anything can happen! " Now Boris is much calmer - with the cash backing of the deal, the likelihood that he will turn out to be extreme is greatly reduced: having $ 120 in his hands, at the current price of $ 100, you can be sure that in the event of a rise in prices, he will be able to buy back potatoes to close the shorts. position.
"Margin call" - it is necessary, Fedya, it is necessary!Now let's imagine what would happen if the next day potato quotes did not go down (as Fyodor would like), but up and reach ₽115. At this moment, Boris the broker will start calling Fyodor in a panic and, periodically breaking into a hot obscenity, shout: “Fyodor, urgently bring the money! If you don’t bring another $ 15 right now, then I’ll spend all your money to buy a bag of potatoes and close your short! ”This situation is called a“ margin call ”- the broker asks to add collateral under the threat of liquidating the position. As long as the current market price (₽115) does not exceed the total amount of collateral (₽120), the broker can buy back the potatoes at any time and not lose anything (all the losses will fall on Fedor - he brought his money to Boris for ₽20, and will receive back only ₽ 5, that is, it will lose 75% of its investments). No exhortations from Fedor on the topic "Yes, this is all temporary, ice cream potatoes, in fact, in a week the price will be no more than ₽60!" Boris the broker will not be worried - he will not want to risk his money for anything, and at any hint of insufficient collateral from Fedor, he will quickly close his short (even if this means the loss of all the money for Fedor).
"Short squeeze" at the vegetable warehouseWe're getting close to what happened to GameStop's promotions. But first, we need to deal with the so-called “short squeeze.” Let's imagine that Fedor is not one such ingenious agronomist in our market, and other experts also suspect that the potatoes are ice cream, and their price will drop. ... Naturally, they also want to cash in on this sacred knowledge, and selflessly short the root crop market. At some point, it turns out that the total volume of short deals is approaching the volume of the entire potato market. As long as the market is in equilibrium, nothing terrible happens: the price is stable, Boris the broker is not particularly worried, and the expiration date for short trades is different - therefore, the closure of each of them does not have much effect on the situation on the market. unexpected news: "British scientists have proven that frozen potatoes protect against covid!" Boom, prices for potatoes immediately jump from ₽100 to ₽130 - brokers instantly present margin calls on all short trades. Naturally, not everyone has the money to add collateral; so most of the short positions go to liquidation. And here the fun begins: a huge number of square-eyed Fedorov are running around the market trying to buy potatoes to close their shorts. And it is not enough for everyone! Worse, the sellers, seeing such excitement, think: "Well, if everyone needs my anti-covid potato so badly, then I will probably offer it not for ₽130, but for ₽150!" Fyodors are shocked, Boris is trying to drip validola with one hand, and with the other, he sends applications for the elimination of even more short positions. In fact, "short squeeze" is an anomalous situation when a small initial impulse triggers a self-sustaining cyclical process, in which each next loop leads to even more significant consequences. Paradoxically, in financial markets, an increased number of those who bet on a fall in prices (that is, “short”) can eventually lead to an uncontrolled rise in quotes - and the short squeeze is precisely the mechanism providing this.
How to overclock the price: "gamma squeeze"So, we now have enough knowledge to understand the origins of the GameStop situation. In January 2021, the volume of short trades in GameStop shares exceeded the total amount of outstanding shares (this is possible, since the same share can be borrowed and sold multiple times). In fact, all the stocks on the market were borrowed, which means that the short players in the aggregate had obligations to buy back securities in the amount of more than the securities themselves on the market. This situation was noticed by the guys from r / WallStreetBets, led by our the hero of Roaring Kitty and correctly calculated it: if you provide the proper initial impulse, you can provoke a short squeeze and send the share price into space (as they say on the forums - “to the moon!”). The question remains: how to arrange a short squeeze? How to give stocks an initial upward acceleration? The simplest way would be the usual clumsy approach: start buying up GameStop shares en masse, at any price. A massive influx of buyers into the market will force prices to creep upward, bringing closer the danger of margin calls that are fatal for short sellers. But this method has a drawback - it requires a very large capital, which many small private investors do not have. Therefore, instead of buying the shares themselves, the guys from r / WallStreetBets started buying options to buy the shares.In our potato terms, call options look like this: you come to Boris the broker and agree with him that within a month you have the right to buy a bag from him potatoes for ₽150. For this right, you pay him now ₽10. Boris thinks: "Now the price of potatoes is only ₽100, it is unlikely that it will grow by 50% - how good that this fool is ready to give up whole ₽10 for this useless right!" You think: “If suddenly the price rises to $ 200, then I can buy shares from Boris with an option for $ 150 and earn a whole $ 50 with an initial investment of only $ 10. To the moon! 1 "
Buying options looks like an attractive strategy for many small investors, since you risk a small amount - and you can potentially win many times more.Now imagine a market where a huge number of investors bought call options on GameStop stock from Boris the broker. As long as the current price is far from the strike price of the option, Boris is calm: no one wants to use the right to buy a security at ₽150 to sell it, for example, at ₽110. But as soon as the current price crosses the cherished execution point at ₽150, the option turns into a very valuable thing - and Boris starts to get seriously nervous. After all, a potentially limitless profit for the option holder is a potentially limitless loss for Boris! And the higher the share price rises, the more Boris wants to fix current losses and prevent them from growing even higher. How can Boris not let his loss grow? It's very simple: you need to buy a share at the current quote so that when the time comes to sell it to the option holder, you don't have to take it at an even higher price. If we simplify it very (very) much, then such a situation in the market is called a gamma squeeze ). Option sellers thought their risk was low; and when the prices of shares crawled upwards and the prospects of gigantic losses loomed, they hurried to insure themselves and began to buy these shares at the prices at which they are given now. Naturally, the massive purchase of shares leads to an even greater rise in quotations. The resulting "gamma squeeze" causes a "short squeeze", all these tendencies influence and reinforce each other, and in the end - voila, stocks grow 20 times!
What is the resultThe situation is still far from over, but at the moment the interim results are as follows: The large hedge fund Melvin Capital (more than $ 12 billion), which shorted GameStop shares the most, fell by 30% - it was saved from bankruptcy only by an emergency injection of external capital in the amount of almost $ 3 billion. All of his short positions are said to be closed at the moment. The impudent guys at r / WallStreetBet boast thousands of percent returns. However, while these positions are not closed - this is only the so-called "paper" profit. All simultaneously current holders of stocks and options on GameStop will not be able to sell at the peak and take profits - as soon as they start doing this in large quantities, the price will drop and all this profit can just as easily evaporate. There is practically no one among market analysts who would seriously believe in the fact that the fair value of GameStop shares is close to current levels (it continues to fluctuate wildly in the range of $ 200 and above). Large brokers Robinhood and Interactive Brokers have introduced a number of restrictions on trading in GameStop shares, as well as some other companies, which are discussed on r / WallStreetBets ... Because manipulating the markets is a matter of serious guys in suits, not some murky youtubers and dudes from the forum! As of January 28, GameStop shares are still "shorted" by 139% (more than the volume of securities in circulation) - and this means that the prerequisites for the next "short squeeze" remain. [Upd. 01/30/2021: The pros told me that the information source I used shows data with a delay - so the actual volume of shorts is currently unknown.] In general, after a year, GameStop shares will almost certainly be worth significantly less than they are now. But if you want to earn extra money on this, then be prepared to lose everything. In the end, if the Roaring Kitten team was able to fill up a multibillion-dollar hedge fund - then why do you think you have a better chance? If the article seemed interesting to you, then I will be grateful for subscribing to my TG channel RationalAnswer , where I try to find reasonable approaches to personal finance and investment. In particular, I tried to squeeze all the most important things you need to know about investing in 40 minutes in this lecture "Personal Finance for a Reasonable Person". Pavel KomarovskyP. S. Roaring Kitty's identity has finally been revealed . His name is Keith Gill, he's 34, he has a sort of happy family with a young son, and he's (all of a sudden!) A financial advisor. Now the main question for everyone is whether the SEC will charge charges of market manipulation and how likely is the kitten to sit down? PPS Some people ask why there is a screenshot from the “Selling Game” in the title picture. The fact is that the main character of the film (the real one is not Christian Bale, but Michael Burry) acquired a significant stake in GameStop in 2019, even when they were worth a penny. In fact, he was one of the first to declare that the company was significantly underestimated from a fundamental point of view. As a result of the January events, Burry's profit on this position amounted to more than 1.500% (> $ 270 million) - in general, there is still gunpowder in the flasks!
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