It was just a post about his LEAPS (aka, Long-Term Equity Anticipation Securities — tl;dr long-dated calls) on GME.
At the time, nobody understood his position at all. The top comment on that post?
“Bid-ask spread on these are ridiculous, good luck getting rid of them” lol.
For the next year, every month about once a month, he posted his “YOLO GME” position. Every month for a year he got made fun of.
I caught wind of this trade back in September 2020, a FULL YEAR after this guy was already holding. I also thought it was weird—the dying retailer?
So I dug into the public quarterly reports of GameStop. Every quarter, public companies are required to release what’s called a “10-Q” which is a quarterly report of their financials. You can find them here:
And what did I find? GameStop was actually in a great financial position; they weren’t going broke! In fact, they had a lot of cash-in-hand, enough to pay off all their debts.
So why was it trading at like … $2-4/share?
Next, I looked at their short interest. “Shorting”, for those who don’t know, is when you borrow a stock (from someone) and sell it on the market expecting the price to go down. You eventually buy back the stock at a lower price, return the borrowed shares, and pocket the diff.
So, the short interest was over 100% of total shares. In fact, it was 140%. Which makes no sense—how can you sell more shares than there are shares?
Keep in mind, not all shares are actively traded. In fact, over 75% of $GME is locked up in passive funds and GME board & C-suite.
So really, short interest was like 300-500% of *float* (float is how many shares are actively traded, basically).
Which is insane. Basically, the shorts (which are hedge funds like Melvin) were expecting $GME to go bankrupt and they’d never have to cover (return their shares).
u/DeepFuckingValue had figured this out long before anyone. Even Michael Burry (yes, The Big Short guy) who bought in AFTER u/DeepFuckingValue.
And he bought in, with conviction in his trade, ignoring the haters.
A year later and people start to take notice on reddit. The price has started to inch up, from $4 to $8 to $12 over September and October.
And more people on r/WallStreetBets started buying in.
And then more people.
And then more people.
Which, of course, makes the price go up. So the price keeps going up and more people keep taking notice and so on.
Eventually, the shorts are supposed to cover. But how? They need to purchase more shares than there are in the company. Well, that means purchasing at any price.
So they start to cover, which means buying hundreds of thousands of shares, which pushes the price up more.
And then last Friday, thanks to momentum and growing interest from retail traders, we had what is called a “gamma squeeze.” Which isn’t the short squeeze!
So, quick aside to explain this: Market Makers (the big banks and funds, like GS, Citadel, etc) write options. When they do, they have to remain “market neutral” by law. So there are what’s called “the greeks” on options: theta, gamma, etc. Look ’em up if you’r curious.
“Gamma” is a number between 0-1 that changes on a call as the price of a stock gets closer to the call price. Lets say you buy a $300 call and the stock is $290. Gamma would be ~0.98.
Meaning for every call purchased (which rep. 100 shares), MMs buy 98 shares to be neutral.
As gamma changes, they have to buy more or sell more shares.
On Friday, the price was over every available call strike, which meant that MMs had to buy millions of shares—if a call is “in the money” (stock price > call price) they have to deliver the shares.
So on Friday and Monday, the price ran up very quickly as MMs hustled to cover the calls and settle them.
Then the news took notice and everything went wild. More people piled in, larger firms are piling in on the buy side, Elon, Chamath… and the price exploded.
So that’s how we’re where we are now. Supposedly, a number of shorts have covered. That being said, last I checked, the short interest was still ~138% so either:
(a) the shorts haven’t covered or,
(b) more people are shorting to replace the shorts that covered
When you short, you pay a borrow fee which can change from day to day. Right now that fee on $GME is between 20-80%. That’s like… credit card interest rates! To borrow a stock!
So the longer you’re holding your short position, the more it costs.
Eventually it either costs too much and you have to close your position for a loss, or you go bankrupt. Melvin almost went bankrupt (they got a $2.75B bailout from 2 other hedge funds).
This is where we are now. Where does it go from here? I’m not sure!
Sorry this was so long, I find it really interesting and have been very invested in the story for months 🙂
Also I want to clarify something: all of this talk about regulating retail, investigations, so on? Nothing illegal happened here. It’s legal to discuss stocks and recommend positions. Just a lot of very upset wealthy people crying loudly to the media.
FYI, for those who are here—I meant *delta* here. Gamma is a measure of momentum.
Robinhood (RH) is a broker. They don’t execute stock orders themselves. They sign up customers, route their orders to executing brokers, and keep track of who owns what. RH is also its own clearing broker, so they directly settle and custody their clients’ securities.
Yes, RH is paid by Citadel to handle executing some of its order flow. This isn’t as nefarious as it sounds – Citadel Equity Securities is paying to execute retail orders because they aren’t pernicious (like having 500x the size behind them).
RH customers buy and sell stocks. Those trades don’t settle (settle = closing, the exchange of cash for security) until T+2, two days later. Depending on the net of buys/sells, RH is on the hook to pay or recieve that net cash. That’s credit risk.
NSCC is the entity that takes that credit risk. It matches up the net buyers and sellers, post-trade, and handles the exchange of cash for security. To mitigate the credit risk that one of the clearing brokers fails, they demand the brokers post a clearing deposit with them.
Everyone posts, and if a broker fails, then NSCC takes any losses out of that broker’s deposit, then some from NSCC, then from everyone else (the other brokers).
This is a post-crisis idea encoded in Dodd-Frank that making everyone post collateral reduces the credit risk and systemic risk and such.
So how does the NSCC clearing deposit get calculated?
It’s basically Deposit = min( 99% 2d VaR + Gap Risk Measure, Deposit Floor Calc) + Mark-to-Market … math and jargon!
Let’s use an example. Say Fidelity has clients who bought 2bn of stock and sold 1.5bn of stocks. First, net down buy/sell between customers in the same stock.
Say that leaves 1bn buy and 0.5bn sell. Run some math to answer “that won’t move more than X with 99% odds in the next 2 days.” Let’s say that’s 3% of the net, so 3% * (1bn-0.5bn) = 0.15bn = 15m. That the 99% 2d VaR.
Next, we ask “is any one stock net more than 30% of the net buy/sell” … and if it is, then we take 10% of that amount and add it as the Gap Risk Measure. So if Fidelity customers bought 200m IBM, then add 20m to that 15m. That’s Gap Risk Measure.
Deposit Floor Calc is some thing that looks at the 1bn buy and the 0.5bn sell and does a small calc and adds them, so that if the first calc (99% 2d VaR + Gap Risk Measure) is small, then this floor will keep the overall from being tiny.
Then, last, you add Mark-to-Market. Basically if your customers bought IBM at 140/shr and it goes to 110/shr before it settles for cash at 140/shr, the NSCC has 30/shr of credit exposure to the clearing broker and that amount gets added to the required collateral posted to NSCC.
There are some other items, but that’s the basic idea – full details are here: dtcc.com/-/media/Files/…
The NSCC sets the framework, but it is spelled out in Dodd-Frank that they have to do so by law.
They had 10.5bn in the Clearing Fund as of Sep 30, 2020.
This is the regime post-Dodd-Frank. NSCC updated it’s rules in 2018 to improve the VaR calc and to add the Gap Risk Measure.
How did this impact Robinhood?
Well, let’s say Robinhood had $20bn of client assets starting 2021. Those customers used to trade $1bn/d say. What is the context for Clearing Deposit? Say 2 days it’s a little unbalanced and it’s 1.2bn buy and 0.8bn sell. Ok, that’s probably around 12m, maybe 20m deposit.
If they take in $600m of new deposits and say $400m wants to buy GME. Plus of their $20bn existing, say there is $400m of GME buys over the past 2d. Then the picture could look like 2.0bn buys and 1.0bn sells, which might normally be 30m deposit. But volatility went up. A bit.
Now 99% 2d VaR is much higher. It should be 20x higher for their net portfolio, but the formula will smooth it out some. Maybe it’s ~4x bigger. So just on VaR, they have to post 120m now. That they should have.
The Gap Risk Measure is what kills them.
If GME is over 30% of their net unsettled portfolio, then they are required to post 10% of all the GME buys. So if that’s 800m, they have to post another 80m. And there is no limit to it. As long as their clients are up P&L, the mark-to-market covers it.
But if RH takes in 500m of new money and 300m buys GME, then at minimum they are looking at posting 30m+ from just that exposure at NSCC. They cannot use client money – RH has to use their own resources to post. And if GME stock drops, RH has to post the loss pre-settlement.
The policy goal here is to avoid the central plumbing entities from taking credit risk. In reality, such regulations raise costs and create barriers to entry. It raises profits for entities like DTCC (which owns NSCC and is itself owned by Wall St)
RH offered to open up stock market investing more broadly. They succeeded, clearly. But the regulations didn’t change – there are still pro-Wall St, pro-incumbent rules and capital requirements. It’s one of the most highly regulated industries in our nation.
So @AOC is right to ask how it can be that Robinhood stopped its clients from buying certain securities. And what she’ll find is that the reason is that Dodd-Frank requires brokers like RH to post collateral to cover their clients’ trading risk pre-settlement.
And it isn’t the Fed or SEC who sets the rules. It’s the Wall St owned central clearing entity itself, DTCC, that makes its own rules. So when the retail masses decided to squeeze the short-sellers, in the middle of crushing them, it was govt regulations which tripped them up.