What is UP with GameStop?

So now that I have some time on my hands and a gambling itch that is ready to be scratched, let’s have a look at some of next week’s plays. I’d usually put some kind of disclaimer that would call for caution, but if you’re like me, when you read back this sentence all you see is ‘put’ and ‘call’. So let’s take that hard earned money and bet on some ponies.

Ticker GME. If you read no further, just short this one. If you don’t know what GameStop is, good for you, you’re not a nerd who escapes his/her life in the virtual world of games (like me). GameStop is a video game, consumer electronics and gaming merchandise retailer. They operate 5,500 stores across the US and Europe (and other small countries) and they derive 47% of their revenue from reselling used games. Kids around the world bring their used games to GameStop and trade them in for new ones. Sounds great in theory, except they rip you off more than selling your used car to a dealer when buying a new one. Poor kids, but hey, now’s our time to exact that sweet, sweet revenge.

Their financials actually are not actually terrible. Their assets ($2.4bn) cover their short term liabilities ($1.3bn). They’ve lost money the last three years and while they are not burning money, it’s certainly smoldering. Here’s a chart of their stock performance directly from their 10k in February

It only gets worse from here. They are a retail operation during Covid. They actually got in trouble for remaining open in many states despite quarantine orders. Here is a high level look at their financials:

Ok, so I know what you’re all thinking – IT’S PRICED IN! Well, sort of, look at their recent stock movement:

Yup, that’s a spike people. I know I’m writing this a little late as it dropped today. I bought October 23rd puts first thing this morning, so apologies this is late, but this is still a great long-term short and here’s why.

Sony and Microsoft are releasing next generation consoles WITHOUT a disk drive. Quite literally: Games Stopped [being released physically]. That’s their whole business. So while their balance sheet is ok, retail rents are extremely cheap right now, and people won’t stop buying used games today, there’s no saving this one.

There are two recent precedents for saving a dying company: Kodak and Hertz. And those are two of the most marvelous and heroic cons / financial wizardry I’ve ever seen. Andrew Sullivan has done a plenty fine job tearing these transactions apart, so I’ll spare any additional verbiage, but here’s the short version.

In May 2020 Carl Icahn said “Icahn’t take any more losses” (so sorry) and dumped his 39% stake in the company for a $2bn loss. He’s still rich don’t worry. Hertz filed for bankruptcy and then Robinhood traders started buy its stock in droves. So much so the stock soared 500% and Hertz almost got approved to issue $500mm in new stock to cover their liabilities. It didn’t go through because 1. buying the stock would be a straight transfer of wealth from idiots to debt holders and 2. we really can’t let companies in bankruptcy issue stock to the general public because they will actually buy it. That said, some people made an absolute killing picking up shares for nothing and selling at the top.

Now for Kodak. In 2017, in the midst of the Crypto-Craze, which played an important part in my life, announced the Kodak coin. Sure, no one buys cameras with film anymore, but what if you could buy a camera, and film, with a KodakCoin and see it on the Block Chain?! How exciting! Stock soars 300%.

In July 2020 Kodak announced they were getting into the vaccine game, claiming they would make the ingredients used in generic drugs to fight the corona virus. How virtuous. Stock skyrockets like 7x. Don’t believe me? Here’s the chart:

Honestly, I know Kodak looks like an obvious short, but these guys will do literally anything. I’m not touching it. Truly epic though. Also, just think that our vaccines will be mixed with the same liquid that develops film. I can’t wait to get mine!

So how will GameStop jump the shark? Partner with Microsoft! GameStop entered a multi-year partnership with MSFT to “use Microsoft’s Dynamics 365 portfolio of cloud applications to help run its back-end and in-store operations”. Oh, and they’re going to use Teams for store communication and they will add Xbox All Access to its offerings (which are what exactly again?) to Xbox Game Pass Ultimate Players. I’m having trouble understanding what I just wrote / quoted. I play games and this adds literally zero value to my life. I’m just going to buy games on my console like the rest of the civilized world. I’m also getting a PS5, but that’s another story.

This is a classic example of a savvy biz-dev person cutting a name-brand deal that offers zero economics to GameStop and free marketing for Microsoft. They probably paid the Jefferies analyst to write a bullish report, saying, and I quote, the partnership “at least partially remov[es] a headline risk that GameStop loses all value from software sales as they shift from physical to digital.” In case you didn’t know, an ‘analyst’ on the research desk of an investment bank is actually the most senior position (and well paid).

Let’s examine that quote – GameStop is “shift[ing] from physical to digital”. How? The console is the store. Why would Microsoft offer better economics to GameStop than to themselves? Even if they did, how would GameStop manage to make any margin whatsoever? Also, I’m struggling to see how ‘partially removing a HEADLINE risk that GameStop loses all its value’ is bullish.

Beware the Short Squeeze

When a stock that has been shot in both legs, it’s shoulder and somewhere on the torso, but then receives a huge shot of adrenaline, it can cause a serious stir in the capital markets. Anyone who wrote calls is now stuck having to deliver shares they never expected to deliver. Also, anyone caught short – meaning you are shorting the stock – is going to receive a margin call. In both cases, anyone short needs to buy shares on the open market and very quickly there is an environment where there are more buyers than sellers. Yes, this applies to GameStop. And this is what is currently happening.

But if the world is at all reasonable, which we all know it’s not, the stock will come crashing down to reality. So on the morning of October 9th I bought short term expiration puts. As the stock continues to slide, well if, I will add to that with more long-term puts, finally exacting my revenge. I am hoping to take bundles of cash from the companies that took pennies from me as a child.

I’m only sort of kidding. I never actually wish the demise of any company. This is merely an amusing blog, but it’s never lost on me people will lose jobs as the great capitalist machine gobbles up one industry in favor of another. Or I could be wrong, and in that case, I lose money.

Also quick note. I’m generally long biotech right now: CTLT, NVAX, CRSP, ALLO, SGMO, VKTX, EDIT, NTLA. I also bought Palantir at IPO and FUBO at IPO. Keep an eye on Fubo. They announced they might get into sports betting. If that happens, r/wallstreetbets will skyrocket that thing to wherever TSLA is at the moment. I just bought and figured I’d do the research later, if at all.

Whale Hunting

I know it’s been a while and boy have I been busy. Quick personal update: I took a break from straight up gambling on the market to really focus on enjoying the outdoors and everything life has to offer. And what a mistake that was. It’s not great out there people. Let’s stay indoors and upset our neighbors. Maybe drink a little too much. It’s not a problem if it’s a pandemic.

Options Trading: Is It Time to Stop?

As you all know, up until about 2 months ago, I was employing the strangle strategy, which means I was buying both calls and puts on the same stock. Volatility is typically priced by most models ‘daily’ and uses highs and lows to compute daily volatility, but once the market started moving intraday either up or down, those models became steaming piles of shit. I typically just held for the day and never stayed around for an open or close. That worked fine; here are my returns in case anyone is wondering:

I’m the light blue line in case anyone can’t figure that out by process of elimination. The dark blue is all of my boring portfolio. So, not tremendous, but not bad. I also never had more than 30% of my portfolio in options. I’m not going to calculate my Sharp Ratio, but it’s obviously fantastic. Also, I didn’t start trading options until that bit spike in the light blue line :).

And then I stopped trading. As some of you know I put a bit of money into Biotech. Biotech hasn’t really worked out, but I was saved by Moderna (the shadiest of all vaccine producers; I will not be getting my vaccine from them). I could have a whole other post on politics and drug prices, but ehh, I’m not sure I care that much.

But while I may have stopped trading options, r/wallstreetbets has only exploded in popularity. Have a look at this chart, individual investors trading a pathetic number of options (that’s me folks) have absolutely changed how the stock market works. 

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And look how much spending on premiums has gone up:

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But why does this matter? How does it drive up the market? Well, when you sell a call option, should that call option you sold become ‘in the money’, you now have to sell those shares to the owner of the call. That means, unless you hold the shares, which no true gambler does, the option seller needs to buy shares of the underlying security on the open market. That increases demand, hence the price goes up. It’s a vicious cycle. The faster the price goes up, the more these small investors pile into short term options. Every week when options expire call sellers are forced to snap up more stock. Oh, and here’s another graph to illustrate my point everyone is buying short term expiration options:

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Apparently I wasn’t the only one with this strategy! And I thought I was a snowflake. More on all that later.

In terms of total options value, nominal value of calls traded on individual US stocks has averaged $335bn a day over the past two weeks, according to Goldman Sachs. That is more than triple the rolling average in 2017 to 2019 (source, reddit – I might as well be honest when I take something from the most reliable source of news on the internet). In July Goldman also reported for the first time ever the average daily value of options traded exceeded shares, with July single stock options volumes hitting 114% of shares volume. I mean, this is bad for a lot of reasons, but mainly because there are going to be enough options sellers who can’t cover their exposure and the ripple effect will begin. The drop will be probably faster than we’ve ever seen. How far it goes, completely unknown. The Fed will likely just step in and hand over our future social security to banks who will just write-off massive client losses.

So, should you stop trading short-term options. Short answer, yes. There’s still money out there, but the premiums are too expensive and once all these tiny, pathetic, low-life quarantine-bored retail investors get wiped out, they will go away. It happened during the Crypto craze and it will happen again. There’s probably still money out there, but I’m not going to try and time it. And here is a great specific example why

Softbank: The Donald Trump of Startup Investing and Screwing Over the Little Guy

First off, thanks to Mr. McG for inspiring a lot of this post. He sent me a great podcast about Softbank’s recent move into equities. And of course Softbank is evil and stupid. It’s just so much money that every autist in America is going to follow them straight to the pits of financial ruin and Softbank will probably partially¬†pull¬†out just before then.

Basically Softbank bought about $4bn worth of calls exposing itself to $30bn in equities (I have no idea how that doesn’t translate to $40bn, but my investigation stops here folks). How does that compare to the $33.5bn per day ($335mm notional, well probably)? Well it’s obviously not much, but depending on where they are placing their volume, it can certainly encourage the retail market to do dumber and dumber things. They specifically dumped money in to Amazon, Microsoft, Apple and Tesla. So, yeah, it’s a big deal. Dealers selling calls into this already hot market got caught in…wait for it…I love saying this…it’s arousing…a massive Gamma Squeeze. 

What’s a Gamma Squeeze you may ask? Well don’t ask Google, it doesn’t know That’s why I’m here, to misrepresent facts. Gamma is one of the 4 greeks, which are risk measures for an option. Delta represents the change in an options price resulting from a change in the price in an underlying security. So an in-the-money call option will have a delta of about 1, meaning a $1 change in the security’s price will increase the price of an option by $1. An at-the-money call option could be around .5. So for more volatile stocks that are out of the money, they tend to have higher deltas and your blue chips have a little bit lower. Gamma measures the change in delta. Gamma is an indication to traders of what to expect of delta in the future (right, it tells the future). So for a gamma of -.8, that means a $1 change in the price of the underlying security will increase delta by .008 (remember options represent 100 shares and for the Greeks everyone likes to divide by 100). In short, Gamma is small for deep out of the money and deep in the money options and it’s largest when options approach at-the-money.
Here’s a chart to illustrate a gamma squeeze, courtesy of ZeroHedge:

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So as more investors piled into short expiration calls, the delta and gamma shot up. You can see in the bottom chart that put-call skew is at an unprecedented level with practically no one short. So anyone who sold calls in June (end of June is when Softbank bought) was forced to buy up the underlying security because their risk, as measured by gamma, meaning an increasing delta for call holders increasing exposure for call sellers, increased (sorry, I’m not editing that sentence). So the strategy is to take a large holding in a single stock. Then buy an outsized number of call options in the hopes it sparks more investors to buy call options, not just shares, because…leverage…and then force call sellers to snap up even more shares of the underlying stock at a premium because there are no sellers. Then sell your shares into a frenzy for a nice profit. Remember one option represents the right to buy 100 shares, so a small ripple (ahem, gamma squeeze) in the options market that creates a small wave can have large consequences for the volume and volatility of the underlying security. None of this has anything to do with actual value. Who does value investing these days anyways?

So yes, Softbank is kind of an asshole. They are benefiting from retail investors chasing the market and they are choosing what stocks to pump. They have enough dumb money behind them to create demand for an asset that is solely based on speculative risk and forcing dealers to hedge. It’s not illegal per se, but individuals don’t understand how much risk they are actually taking on. AAPL’s price doesn’t represent AAPL’s earnings and TSLA’s stock price can be seen from outer space despite the fact every car company is desperately trying to make electric cars.

Apologies for the long delay and the fact this post isn’t really innovative in any way, but I found this pretty fascinating. I feel like there’s a bit more light being shed on this massive run-up. More clarity means a safer unwinding. Investors are less likely to get spooked and dump their 401ks at all-time lows. So don’t buy, don’t sell. Don’t do anything right now. Go outside. Or don’t. Go to sleep. Wake up next year.