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Can’t Stop. Won’t Stop. How Game Stopped Nearly The Whole Market

If the White House and Market Makers (legally granted liquidity providers) had not intervened to pressure brokerages to stop trading in these meme stocks, then the whole US stock market could have imploded this week. The WSB (Wall Street Bets) Reddit bandwagon is the market rationally adapting to take advantage of the institutional agents that irrationally underwrite unlimited downsides.

It’s like that moment in The Big Short where Mark Baum wanted to “make them bleed” until the very last minute. His billions in betting against the Big Banks could have gone to zero as their companies would have gone under one by one unless the US Government bails them out as “lender of last resort”.

GameStop (GME) shares became a vessel for wealth transfer from those who promised to pay an uncapped price to the people who took them up on the offer. As Melvin Capital went billions into the red along with fellow short sellers, the original downside exposure was passed up the chain to those who had vested interest in the “at risk” hedge funds. This extends to Market Makers Citadel and Virtu Financial, who run the order books and clearing houses for massive pension funds and asset managers. This could lead to massive losses in life savings of prudent investors. Can we blame them for placing their faith in asset managers?

Hedge funds go under. Banks excessively exposed go under. They are obligated to honour those short positions, so if enough GME longs (i.e. long-holding retail investors) refuse to sell, all these actors get margin calls from the agent above them. They get forced to cover and buy more GME, and sell the rest of their portfolio e.g. Tesla longs, which pushes GME higher, screwing their other shorts who are forced to cover to hedge risk or because they themselves have been margin called.

The net result being GME holders are the beneficiaries of the greatest transfer of wealth in history.

If the SEC or Government steps in, and we don’t allow the loser hedge funds and High Frequency Trading outfits to actually lose when GME shoots up, then it proves the system is fundamentally rigged.

Short Selling and Options Gamma Squeeze

Those betting against GME stock had to borrow shares. They sold these shares into the market to increase supply in the hope of driving the price lower so they could rebuy them at a discounted price. They have to return those shares eventually and in theory they would get to pocket the difference.

Trouble is, they got greedy. They sold more shares than existed (naked short selling). They then have to return those shares. So subreddit Wall Street Bets took advantage of new commission-free trading, dense information channels coordinating millions of speculants to try and bet against these greedy hedge funds. GME shares are, officially, a fixed asset. Massive demand influx drove the price up, forcing massive losses and margin calls on the short-sellers leveraged bets. Billion-dollar private bailouts ensued to keep the ship afloat. Coordinated attacks outside regular trading hours closing the retail communication groups and flooding the market with more fake shares; pressure on retail brokerages with conflicted revenue stream interests (their owners were net short on GME); cronyism getting the White House involved – all simultaneously only goes to show how corrupt the system is.

This turned a “because we can beat the system to make money” ingenuity into a political war against the elites: Occupy Wall Street 2.0.

The other feature which has killed Wall Street is a “gamma squeeze” wherein the market runs out of liquidity (no supply of shares). Interactive Brokers Chairman admitted they didn’t have the capital to pay out the winners. Not just pay out GameStop winners, but to service the entire market. No capital means no shares and infinite losses.

Where the shorts are obliged to “cover” (buy back) the securities at higher prices as they get margin called, there was also deep-out-of-the-money option trading going on. The writers of these leveraged derivative products had to hedge (protect) against the infinite risks to have their sold calls exercised, by buying the GME stock steadily – ready to deliver these promised shares to the investors if the price target (strike) is reached. These middlemen in the transaction were short stock (gamma). With no let up in the buying from both short-sellers going bankrupt and the Reddit armies and the options writers, orders were being executed for GME in the $1000s per share as any “ask price” were being bought.

The mounting losses by hedge funds could spill over to other areas of the market as they close out their other positions, which is what caused the S&P index to fall sharply this week. The risk is that they go under, and take banks, pension funds and asset managers with them. This ripple effect could have tanked the whole market, leading to a transfer of wealth never seen before.

End of GME?

Naked short selling needs to properly be clamped down on. And either the retail trading infrastructure needs to improve or commission trading needs to return so we don’t risk the brokerages going under forcing taxpayer bailouts up to $500,000 per account because of market volatility.

The price discovery longs and shorts both contribute to, protects investors from corporate greed and over-exuberance and is being disrupted. Longer term this hurts the individual retail participant and pension saver more than the big firms. However, the retail bandwagon wouldn’t be jeopardising the entire system if it weren’t for the naked short selling greed getting in the way of prudent risk taking.

The only way out of infinite GameStop prices was to stop the market. Or else risk everything collapsing. It will take the asset managers losing big to force the system to correct itself. A more decentralised system is the answer.

Regardless, anyone who lost or made money did so because of where they chose to allocate their money.

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Richard Bolton was born in the UK and is a Manchester University PPE graduate. He is a financial planner. Areas of intrigue include global political affairs, culture and nascent technologies. In his spare time, Richard is a keen sportsman and investor.

Richard Bolton
Richard Bolton was born in the UK and is a Manchester University PPE graduate. He is a financial planner. Areas of intrigue include global political affairs, culture and nascent technologies. In his spare time, Richard is a keen sportsman and investor.

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