Will GameStop Change the Way We Trade?

No, but this sounds like a good time to pitch an idea. Also, this is just a brain dump, not a pitch, so comment if you find holes or egregious errors.

Hedge funds are now making a lot of money shorting GME. Individuals can’t short the stock because no brokerage will lend the stock to them. Hell, individuals can’t even buy the stock because brokerages don’t have enough collateral on hand. Robinhood is single-handedly robbing from the poor and giving it to the rich. We should all dump Robinhood like we just found out we’re actually its second family.

The reason short squeezes even exist is because trades settle with an exchange of shares of a company. The actual asset passes ownership from one entity to another. A Stock Option buys you the right to purchase or sell a stock at a specific price at a specific time. So, in order for that option to convert to anything of value, shares need to exchange hands. When there are no shares available, or more shares need to be bought to cover existing agreements than are floated on exchanges, voila, the GME fiasco. Good work main street, you sure made a point.

I was very frustrated there was no mechanism available to short GME. Brokerages like Robinhood who operate at the behest of behemoths like Citadel literally sent out a notification saying they were not allowing individuals to buy the stock. They then limited the ability to buy a list of heavily shorted stocks (GME, AMC, NOK, BBBY, etc), then removed the ability to buy them again, then limited again. Tomorrow they might just empty my account, because, why the fuck not? In effect, they wanted to slowly bring the price down by only allowing selling. Baby, I love you, but I think we should take a break. Two weeks later: ‘hey, u up?’. Two weeks later: ‘new phone, who dis?’

If only selling is allowed on Robinhood, dare I ask who the buyers are? I’m very mad and you all should be too. It’s so fucking patronizing to be told you can only take one side of a transaction.

So, blind rage aside, I thought “why isn’t there a mechanism to bet on the price of a stock”. Then, I remember from my finance days, “oh yeah, it’s called a derivative”. A derivative contract is, and I quote from Investopedia, “a financial security with a value that is reliant upon or derived from, an underlying asset or group of assets—a benchmark”. Great, only big banks and hedge funds can create derivatives, let alone trade them.

As an old Millennial (we need generational name), when I think about derivatives it just screams ‘smart contract’. A smart contract is effectively a derivative asset that is logged on a distributed ledger. The contract is executed by code and verified by miners. Intermediaries can exist to verify more complex contracts. 

Now more than ever do we need to democratize the creation and execution of smart contracts. Exchanges would provide an order book where ‘buyers’ would bid on a price target before a certain date and sellers would either write the contract or wait for a better bid. Voila, no shares exchange hands and we can freely bet on plain-sight market manipulation. It won’t proverbially fuck the man, but at least there’s some action (not proverbially).

But we can do even better. No one in their right mind would short a stock right now. Sure, you can buy put options, but they are mighty expensive given all the recent volatility. What would be better is to buy an insurance policy in case a stock ever hits a certain price. Insurance premiums have no expiration, though they can be cancelled any time by either party (negotiable, duh). In fact, some of the most lucrative trades in history used this exact mechanism.

In March 2020 Bill Ackman of Pershing Square Capital purchased a monthly recurring $27mm premium to buy credit default swaps. Three weeks later the pandemic hit the US and he profited $2.6bn. A lot of people think made a $27mm bet that returned $2.6bn. That’s not quite true; he got lucky on the timing. Otherwise he would have continued paying that premium every month until he went bankrupt. That’s what almost happened to Michael Burry (played by Christian Bale in the Big Short and most recently a major GME stock holder) as he paid premiums to buy credit default swaps. So many people don’t understand the recurring premium payment part.

Derivative contracts could be quite useful for a variety of types of insurance for the normal US citizen. I’ve always loved the idea of home equity insurance. You can pay a premium to insure the equity value of your home and should it drop below a certain amount, as determined by a basket of other assets like similar home sales in the last month, an appraisal, etc, you get a payout. That helps protect against large drops in value in the case you have to move for personal or external financial reasons. I’d probably buy it.

Yes, it’s pretty broad, but it would be cool to see a few fintech startups start to democratize more exotic contract types and make them available on the public blockchain. Also, imagine how much easier it would be to value a portfolio of assets if you could query all their underlying data right in the contract itself. You could even value the contract by how much diligence is included with each contract in the portfolio. Today loans are bundled up, given a rating, and then sold. The underlying loan documents probably make their way to the owner, but I’m sure there’s like one sleep-deprived 20-something analyst who actually knows where they are. Instead, anyone in the world could query the underlying data used to underwrite the asset and report or trade on that information. Wouldn’t that be cool. No more dark pools, opaque asset bundling and absurd fees for literally removing information needed to value an asset. And no more rating agencies getting paid by the institutions who are selling the assets they need rated. How in the actual fuck does the government allow that (can you sense I’m just a little perturbed at the US’s ability to regulate financial activity right now)?

And last point. I feel really bad for the whole ‘Diamond Hands’ Redditors who could have sold GME at literally any point at $100+, $200+ or $300+. These people lost millions trying to bankrupt hedge funds with tens of billions in capital backed by other funds with hundreds of billions in capital. It’s a nice idea, but big fish eat small fish, bigger fish eat big fish, sharks eat big fish, and hedge funds kill sharks with fucking dynamite. If anything, every major financial institution is going to have at least a voting share in anything that facilitates transactions between ‘non-millionaires’. It’s back to betting on football games people. Who’s got Brady for 5 Tds in the first half? I’ve won that bet before.

Leave a Reply

Your email address will not be published. Required fields are marked *