Month: January 2021

Robinhood is Down and Reddit is a Terrible Place for New Investors

Yesterday was crazy. Multiple brokerages halted trading of GME, AMC, NOK and other heavily short squeezed stocks. Robinhood was the most egregious offender; it disallowed its customers to buy these stocks, but allowed them to sell. Halting buys put downward pressure on the price and allowed hedge funds with access to Robinhood’s order book to pick up shares in anticipation of a pop when customers were allowed to buy again.

It’s bad however you think about it.

The reason brokerages are giving for halting trading is they ran out of collateral. Specifically, in the case of Webull, the Depository Trust & Clearing Corp instructed its clearing firm, Apex that collateral requirements had increased by 100%. WeBull was forced to halt trading on certain stocks until they could meet collateral requirements. Schwab halted trading on some stocks too for the same reason.

Robinhood used to use Apex to clear its trades until 2018, but then switched to clearing its own trades in 2019. It appears as though they tapped banks for $1bn to cover increasing collateral requirements due to increased volatility. But they only stopped buying, not selling.

Robinhood derives 80% of its revenue by providing hedge funds access to its order book to execute client trades. These banks and funds pay hundreds of millions to execute trades placed by individuals and they basically front run these trades, making a small profit themselves. The loser is the investor. You think you’re making a commission free trade, but you’re not. You’re buying at above market prices and sending a few pennies to Robinhood and whatever bank or fund executed your trade. Schwab derives about 3% of its revenue from this practice for reference. Reminds me of a quote from Blow: “Hey, am I wearing lipstick…”

Their decision to halt buying, however, needs to be investigated. I have no idea how that doesn’t only benefit hedge funds and banks and hurts their customers. I guess we know who their real customers are. I’m going to buy some DogeCoin, hold it for a week. Then close my account and move my fun money to some other brokerage.

Is the SEC Investigating r/WallStreetBets?

No. In fact, while I think this subreddit is ‘interesting’, it has a few contradictions. The community has created a sort of language of their own, which is not very inclusive. I think the term ‘Gay Bear’ is one of the most egregious (the subreddit does not encourage anyone who thinks the market or a stock might go down). There are many, many others.

The biggest issue with the offensive language is that it is not inclusive. Normally I wouldn’t think this is a big deal because it is a subredit; subreddits are specifically not inclusive and cater to a niche group of anonymous people. If you don’t like what you see in a subreddit, stay away from it. That’s like most of the internet. However, r/WallStreetBets is now consistently on the top of the front page of Reddit. It is responsible for sparking the rallying cry of individual investors to take a stand against hedge funds who for since the dawn of their existence have quietly manipulated the markets in their favor by moving large chunks of capital around all while trying to convince the rest of the world they are on the other side of the trade.

And it’s working. There is speculation that Melvin Capital received $3bn from Citadel and Point72 to shore up its finances in the wake of closing out their short position on GME. r/WallStreetBets now has 2 million subscribers and every day users rally around buying GME to continue and force a short squeeze.

The narrative a few days ago was simple; buy the stock, don’t sell, and these hedge funds will be forced to buy a tremendous amount of stock to cover. Hold your positions, and make a fortune. I don’t pay for any services that allow me to see daily short interest, but my guess is that after Melvin Capital and Citron Research closed their positions the short interest is way down. However, people are still buying the stock. Remember the top shareholders of GME are institutional funds, including hedge funds run by a few really rich people, like Michael Burry and Ryan Cohen. I’m in no way saying they are bad guys, but they don’t need a donation from poor Millennials and I’m honestly not sure why so many Millennials want to give them money.

Brief aside: I know the F word is so taboo right now. Even uttering it on the internet can make you a target for trolls. That’s right, Fundamentals is actually a dirty word. However, they are still a thing and it will still determine long-term value. Every euphoria ends and every fad changes. History doesn’t repeat, but it rhymes. Some people will be on top of every next hype-cycle, but in order for it to be a hype cycle, that means a lot of late entrants will be transferring wealth to a few early entrants. So if you don’t know what to buy and don’t want to risk giving handouts to rich gamblers, buy something with strong fundamentals.

So, lastly, r/WallStreetBets is actually spreading disinformation. Well, here’s how I’m interpreting this video from the founder and previous moderator of the subreddit

“It’s been a constant thing for them for the past few years…there’s just a running joke, whenever things got kinda hot a little bit, they get a lot of attention, they set it private, it sends all sorts of speculation that the SEC is investigating them”

So, to be clear, this isn’t terrible behavior. Jaime Rogozinski goes on to say, “it’s complete bs” because no one would actually think setting a subreddit to private would actually protect them from the SEC. However, if you are just browsing Reddit, you may still think the SEC is investigating them. What follows is outrage that the system is working against the little guy. This is also fine, because, well, it is, but just not in this particular instance.

However, now that 2mm people are pushing specific stocks, the subreddit is branding buying GME with saying fuck you to the man and Wall Street. It’s really not the case. Buying GME makes a few early entrants, hedge funds and institutional funds super rich since they own the majority of the shares. Also, does the executive team of GME really deserver to get rich? The company failed over and over to move into the digital space and greatly mismanaged its cash.

GameStop literally asked it’s employees to dance on TikTok for an extra shift during Black Friday for a whopping $9.25 / hour (source). Do you really want to pump this stock now and reward GameStop’s management team?

So by inciting rage in uninformed investors by saying the SEC is investigating the little guy, r/WallStreetBets is effectively using disinformation to pump a no-good stock. I support more individuals buying stock, but don’t think that just because you have a RobinHood account and are buying GME or AMC that you are part of the solution. All people should open accounts, buy strong fundamental stocks that make a positive impact in this world and hold them for a long time. That’s how you build wealth. There’s literally no trick. You don’t need money managers, you don’t need to do extensive research. Low fee index and mutual funds run by ethical companies is just fine. If you know a little about a few stocks, go ahead and buy those. It’s literally all quite simple. I can’t believe more people know what a short squeeze is than they understand what P/E multiple is.

GME, A Familiar Story

It’s a familiar story. Some millennial sends me a text saying “Hey, I just bought my first LiteCoin on Coinbase!”. My response is “Jeebus, you probably paid a 2% commission, why didn’t you just use GDAX?”. I hate fees and Coinbase charged a 2% “I don’t know what this is, but my friends are doing it” fee. This was December 2017. During 2017 Bitcoin, Ethereum, Ripple, Monero and countless other nameless crypto currencies rose to internet fame increasing in value over 100x. Initial investors didn’t believe the hype, but Reddit coined the term ‘Hodl’ and we held on for dear life as our net worth bounced around 20% daily.

Then came the reckoning:

If you bought at the top, you lost 25% in a few days, 65% within a month and 90% by the end of the year. If you’re still holding today, you’re actually up! The price of ETH is $1,343 today, but that’s a completely different story.

Ok, Let’s Talk About GameStop

To be clear, there has been no news released by the company since January 11th, when it announced that their 9 week holiday net sales were $1.770 billion, a 3.1% decrease compared to 2019 (source). E-commerce sales were up, but as I said in an earlier post, both Playstation and XBox are trying to move to digital sales only for new games. Bears, like myself and a few other badly hurting hedge funds, thought this brick and mortar retailer was a thing of the past and would be swallowed by Covid closures. After my post about selling my short here, I stayed the hell away from GME, ironically, only because shorting was too expensive, meaning I still thought I was right, but not at that price.

Bulls had a good case, however. I’m going to embed this whole Reddit post here; it’s actually brilliant. In effect, u/delaneydi is arguing that given the companies strong cash position (it’s still strong), projected EBITDA, and ridiculously low EV/Sales multiple, the price of the stock doesn’t reflect it’s true value, which is modestly higher. As you can see, no one cared about this post as it generated a whopping 33 up votes. I can’t even link to the comment section, but in short, this user was lit tf up. Even r/WallStreetBets was short this stock in 2019

GameStop Investment Thesis from r/wallstreetbets

However, some major investors agreed. The first one was Michael Burry of Scion Asset Management, but you may remember him as played by Christian Bale in The Big Short. He quietly opened up a long position as shown in a 13F filing, which he bought in Q3 2018 worth about $6.7mm with a basis of $12.61 / share. He added to that position over the course of 2019 and even bought shares for as low as $3.50 mid 2020. However, towards the end of 2020, he liquidated 36% of his position at around $10 / share, which probably represented a measly 40 – 60% gain. According to his latest 13F filing, he still owns 1,703,400 shares, which would be worth $562mm, though that filing is a bit old.

My favorite part about Burry’s investment is that he actually saw the same value as the Reddit user. He issued a press release in August 2019 urging the GameStop board to use $237mm to buy back 80% of the companies stock. His reasoning was that during the month of August 2019, the number of GME shares traded exceeded the total number of outstanding shares. GME could theoretically buyback and retire 80% of the total shares, dramatically improving earnings per share. He then goes on to say that the GME missed lots of opportunities to move into the digital space, so while the company shows no large upside, a bit of financial maneuvering could yield a decent upside for shareholders. Smart guy. I wish I knew all this was going on.

Next up, the Ryan Cohen, the founder of Chewy, Inc announced his hedge fund dumped $5.8mm into GME stock in August 2020 and continued to add to the position, totaling $75mm at a price of $8.43 / share. That’s now worth north of $1.3bn. In the mean time, the shorts continued to pile on, reaching 120% short interest towards the end of 2020. It made sense, the company was burning $100mm per quarter and had no discernable digital strategy to address the new consoles. Bulls said that despite the fact digital was overtaking physical games, the demand for video games continued to go up, and, as they say, a rising tide lifts all boats.

The Big Short Squeeze

So here we are: GME is the most epic short squeeze in all of history. But how could it happen. Informed and successful hedge fund managers had LONG positions. Multiple posts on Reddit called out a the fact there was a 120% short interest (which cost 60% to borrow for the privilege) with a potential basis of $7 while the share price was hovering around $10. If the stock hit $15, that means the shorts were going to be out over 100% of their initial investment.

Side note: I’m never going to short a stock / I haven’t in years (I only did it to see how it worked, but I’m over it). When you short a stock, you effectively borrow the shares from someone (usually your broker), and sell them. Selling the shares creates downward pressure on the price (just think buyers only want to buy something if the deal looks good, and if you think the shares will go down, odds are other people do, but to a point. So they have a price, but it’s lower than what it’s currently at). Ironically, selling shares you don’t own creates downward pressure on the price and is good for the short seller! The catch is that the short seller needs to deliver those shares back to the original owner, basically whenever the original owner wants them. In order to borrow the shares, you pay the original owner interest. If the shares are volatile, the original owner charges a hefty premium. So by simply staying in the trade, you are losing the interest payment. On top of that, if the share price, say, triples, you have to buy the shares back on the open market and return them to the original owner. That means your exposure is literally infinite loss. So imagine borrowing $100 worth of GME at $7 (14 shares) and selling those shares. You owe the person you borrowed those 14 shares from, well, 14 shares of GME. If the price goes down to $3 and you want to give the shares back to the original owner, you buy 14 shares at $3 for $42 and voila, you just made $58. However, if the shares go up to, say, $330, and the original owner wants those shares back, you now have to buy 14 shares on the market for $4,620. You just lost $4,520 on a $100 investment. Great work. Oh, and your upside would have been $100, only if the company went bankrupt.

Main Street Crushes Wall Street

Ok, so back to the main event. In late 2020 and early January this year, Citron Research and Melvin Capital released statements that they are short GME. By January 12 the short interest on GME was 139.67%. That means there are more shares sold short than are floating on the exchanges. The short squeeze is simple, the price goes up, and over 100% of the shares need to be sold in order to return. If you’re wondering, short interest can exceed 100% because shares are borrowed and sold multiple times. It’s an utter disaster. When the price spikes, everyone wants their shares back because they’re afraid the borrower won’t be able to pay. In the case of GME, they should be afraid.

Ok, so Citron Research and Melvin Capital got crushed. Citron tried to live stream an event talking about their short position, but got shut down by hackers. Redditors, especially those on r/WallStreetBets really don’t like Citron Research. Citron, the notorious short sellers, released statements that they thought Palantir and Fubo were easy shorts, sending the price in a downward spiral after a meteoric rise. Now that both Citron and Melvin exposed their short positions on a low market cap stock with incredibly high short interest to begin with, Redditors saw a huge opportunity. Buy, hold, buy some more. If the price goes up, over 100% of the outstanding shares will need to be BOUGHT, forcing the price way up. If there are limited sellers, those sellers can demand a huge premium. That is exactly what happened. Main Street crushed Wall Street.

Somehow This Gets Political And IT NEEDS TO STOP

As of today, Robinhood stopped its customers from buying shares of GME, AMC, NOK and other heavily shorted stocks that experienced a short squeeze over the past week. r/WallStreetBets Discord stopped working – it looks like that was due to unprecedented volume – and its Reddit page went down for a bit. These things are concerning, but happen when growth is hyperbolic. The subreddit has gained over 1mm new users over the past few days. People are downloading RobinHood and buying GME as their first stock purchase ever.

To be clear, this is not Wall Street taking from Main street. It’s Main Street taking from Main Street. That is actually how America should work. I honestly think it’s common sense not to invest in anything you don’t understand, so if you do, I don’t feel sorry for you if you lose money. Nor should the government care. If it’s fraud, or something dishonest, yes, government please step in and enforce reasonable laws. But do not shut this down.

I was very disappointed to see this press release:

“With stocks soaring while millions are out of work and struggling to pay bills, it’s not news that the stock market doesn’t reflect our actual economy. For years, the same hedge funds, private equity firms, and wealthy investors dismayed by the GameStop trades have treated the stock market like their own personal casino while everyone else pays the price. It’s long past time for the SEC and other financial regulators to wake up and do their jobs – and with a new administration and Democrats running Congress, I intend to make sure they do.”

Elizabeth Warren

The government has no business regulating hundreds of thousands of small investors (she literally doesn’t understand anything). They know the risks; it’s a casino and people just want to play. Hedge funds have been throwing their weight around for years, manipulating the markets in the shadows. It’s time for Main Street to do the manipulation and lay in the proverbial bed we made. Even Citron Research came out with this tweet, basically telling the SEC to stay TF out of this battle.

Put your political leanings aside (hey, I just called out Elizabeth Warren), AOC is dead-on here

The Wealthiest Man in the World Should Stay Out of This

Not cool Elon. If you remember, Tesla used to have a huge debt problem. Citron Research was one of the loudest short sellers of Tesla, forcing it to constantly worry about its ability to pay back its massive debt load. Elon Musk (more than) entertained the idea of taking the company private because short sellers kept pushing the stock price down, making debt obligations more onerous. They were obviously wrong and short sellers lost $40bn shorting Tesla in 2020.

Elon Musk tweeted this out because he knew Citron was getting crushed by shorting GME. He literally tweeted out ‘Use Signal’ in response to a (misinterpreted) WhatsApp privacy policy change and some unknown penny stock Signal Advance Inc shot up from $.60 to $38. So, yes, he knew this tweet would move the market. This kind of behavior shouldn’t be tolerated. If not illegal, it’s highly immoral. Every hedge fund knows whats going on with GME. Main Streeters who don’t own stock have no idea. It’s a known and sad fact that Americans follow Billionaires blindly and it’s likely a lot of people bought GME after this tweet.

As of writing this, GME is down 62% (coming back though). No one should lose half of their investment in an hour unless they are fully aware it can happen. I don’t think we should regulate it, but rich people don’t need to purposefully dupe tens of thousands of people because of a grudge. That said, if I were him, I would have done the exact same thing. If you come at the king, you best not miss.