Game, Set and Match [UPDATED]

Game Stop is an interesting story that needs to be told

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First an important qualification: This post has nothing to do with any recommendation trade in any security mentioned. If any one claims such, they are a liar.

The Wall Street casino was jolted this week with news that several shark hedge funds had to close out massive short positions against a stock called GameStop due to the stocks rise as depicted in this chart.

( Update: Our view as of 01-Feb 21 is that they said they closed but are lying in wait hoping that folk would buy it )

This is how Game Stop opened today on 29th Jan 2021. Could be bad for the hedge funds on the other side. This reminds me several years back  of those who were shorting the Swiss Franc as part of an arbitrage strategy and suddenly the Swiss Franc exploded and a million hedge funds lives were lost in the blink of an eye – like the effect of  a direct hit from a  Deathstar.

Gamestop share price eventually closed at $325 on Friday, a miniscule gain of 70% for the day.

According to the Wall Street Journal, these included Melvin Capital Management and Maplelane and the bug bear of all Hong Kong penny stock speculators, Citron Research.

According to Investopedia, the losses on GameStop alone was $5 billion US as of Jan 27th. One key issue is that some reports say 120% of the stock has been shorted. So if any fund initiates a new short position, it just adds to this mismatch between supply of shares, namely the shares that are available and demand, which increases as the price increases due to the massive short.

Market Insiders in their post over here suggests that the losses for the short funds could be about $19 billion on Gamestop alone as of Friday. Reuters, reported that losses on US short positions were $70 billion as of Wednesday close, the day when Gamestop stock hit $400 intraday. Of the $70 billion loss, $20 billion were probably from Gamestop alone.

Our updated view as of 30th Jan 2021

We can actually have a good idea of why everybody is panicking by merging together 2 data sources. The first is the short sales that are reported by FINRA regulated members, aka Banks and Hedge Funds against the actual stock price.

Folk have to understand that when the banker’s favourite hedge fund, like Citadel gets hurt, then the politicians will come on tv and start to scream. The issue to us boils down to risk management. If the Fed and the Regulators were asleep at the wheel, and allowed JP Morgan or Goldman Sachs to recklessly bank roll their hedge fund sidekicks to the tune of billions, and the market seizes up because one of them goes down, do you blame the Reddit folk,  the bank management, the Federal Reserve, the Office of Comptroller of the Currency , the SEC or the CFTC? 

None of them. You blame Trump and Trumpism, I guess. See the orange blonde hair and the orange face. (Media should start to foam at the mouth and roll around the road)

You always blame Trump – that is what the lying media has been selling and will continue to sell.

The key thing to understand is the price explosion that happened on Jan 27, 2020, when Game Stop shares opened at $354 per share after closing at $148 per share on the 26th of January.

Now what others don’t tell you but we have managed to piece together by accessing the Finra short interest data over here is that if you look at the trading of this stock over the period Jan 21 to Jan 29, 2020, 74% of the short trades happened before the price explosion on the 27th of January.

In other words, the short traders may kept doubling down their bets as the price went from $19 on Jan 01, 2021 to $43 on Jan 21, 2021 and basically had no ammunition left. Their final stand in the Alamo gunfight came between Jan 22 to Jan 26, 2021. After Jan 27th, when the price exploded to $354, the shorts no longer had any ammunition left.

Also, what others don’t tell you is that this whole mirage about Reddit traders being wholly responsible is not true. This stock is also traded by the big boys who smell blood in the water.  And there is certainly blood in the water.

The last point to note is that currently, there are only 65 million shares on issue. What this means is that any reasonably sized hedge fund which wanted to send shivers down Wall Street only needs to bid up 50,000 Game Stop shares in the pre-market to let’s say $500, which takes about $25 million to execute and Monday will be a bad bad day because most of the short trades occurred prior to the price explosion from $140 to $350. This should rightfully trigger margin calls and liquidation, all the good stuff you hear about in a market crash.

The only saving grace for the short-sellers if if Game Stop does a share issuance at the current price. They are fully within their rights to do so, and they can issue up an additional 200 million shares. I guess with the fate of Wall Street hanging in the balance, no doubt there will be a beeline of bankers calling on Game Stop to do so. From Game Stop’s perspective it does make sense to do some issuance shares to take advantage of this unique situation. The only question is the price at which they do so, and the volume at which they do so and the terms of the issuance. Wall Street is king in this regard and if Game Stop management are not savvy enough, they will be eaten alive.

From CNBC over here.

We want to unpack a couple of things over here, namely the borrowing fee or the stock loan fee. Basically, the borrowing fee is what a bankster (more details below) charges their hedge fund sidekicks for the right to short the stock. In the case of Game Stop, the stock borrowing fee is 30% per annum for existing shorts and 50% for new shorts.

Lets do some maths here.

For simplicity, lets assume that all the stock borrowed is for existing shorts, in this case, the conclusion is even more evident if we account for new shorts.

Based on S3 analytics, 113% of the stock has been sold short, or about 75 million shares. The daily interest charge is about 8 basis points.  So to give you an idea of how costly it is to hold to this position, lets show some figures

 

The table shows that based on a 30% stock loan fee, it cost the hedge funds, collectively about $130 million per week to hold on to the Game Stop short position, based on an average price of $300. It also shows the aggregate value of the short position, so at $300, the short position “consumes” exposure of $22 billion, and at $500, the short position “consumes” exposure of $37 billion.

The thing that is not working in the hedge fund favour are two fold, namely the high cost to hold the short position and the fact is that they are currently already in a loss making position – to the tune of $20 billion if S3 is to be believed. That means they are in a very vulnerable situation – for example if Game Stop opens at $500 on Monday trading, the short position will require a further “consumption” of $15 billion, not even including the $31 million a day loan fee.

Unless the banksters can convince Game Stop to issue new shares or the Government / Fed/ SEC decides to intervene and bail out the hedge funds, the poor hedge funds do look in a weak position. These hedge funds are concentrated lot – it is one thing to spread a $15 billion hit on 5 million Reddit traders, it is quite another thing to spread a $15 billion hit on 10 hedge funds. And worst of all, not all hedge funds are the same. The weakest hedge funds may have to capitulate first, driving up the price as the bank is forced to buy the share to close the position. In such a short closing frenzy, other momentum traders will quickly sniff this out – we won’t be surprised if there is a peak at $1,000 (no matter how momentary it is). But all this assumes that the Federal Reserve does not backstop the hedge funds, they might as well do that to save the banksters.

Note, everything mentioned is our view and if you make an investment decision based on it, you bear the consequences yourself.

The rest explains a bit more context.

We want to actually re-look at this phenomenon from another angle, namely the relationship between players of the Wall Street Casino, namely the big Investment banks, such as Goldman Sachs and JP Morgan and their hedge fund clientele.  Think of investment banks being the crime families in charge of these casino and their hedge fund clientele being their sidekicks.

The 2 are connected through the ‘Prime Brokerage’ service the Banksters offer their hedge funds. We first encountered the term “Prime Brokerage” when reading a book about the collapse of Long Term Capital Management and can give you a bit more perspective about what it means. All you need to do to understand this concept is to go out there and buy a single stock of any of your favorite company.

So let’s say you login to your favorite brokerage, key in to buy your favourite stock – Top Glove, for example. You press ‘send’ and presto – the stock immediately appears on your screen and you are now a proud owner of 1 share of Top Glove.

Well – actually that is a bit of a mirage and Prime Brokerage is a bit about what goes behind the mirage.

Firstly, lets be clear.  At the electronic clearing system level which is the level at which the transaction actually took place, there was never an offer to buy the stock on behalf of the individual investor. The offer communicated to the electronic system was on behalf of the broker and internally the broker has systems to credit and debit your account so that you appear to have ownership. Secondly, there is this whole process of updating the registry of ownership of the stock, the so called Central Clearing Book, which itself could take 1 up to a day, or maybe even 3 days in some markets. Then there is this whole business of buying stocks on margin – or what bankers really think of as giving a collateralized loan to buy a stock.

Now think of ‘Prime Brokerage’ as being the same set of services offered to the individual investor, but multiplied 1000 x. Your individual broker lends you, say $100,000 to buy shares, a JPMorgan or Goldman Sachs may extend $100 Million or even $200 Million to an individual hedge fund as the same kind of loan. Another service offered by these banks is this ability to go-short a stock. You want to short a billion dollars worth of Gamestop shares – no problem, the banksters will go and do the ‘legwork’ of locating the shares.

All of that sounds well and good, but sometimes like what happened in the Matrix, the ‘system seizes up.

We believe that this Gamestop rebellion could be one such case.

Now the issue for the banksters is what happens if they extend $1 billion worth of loans to one of their slimy hedge fund friends to short Gamestop and the stock goes to infinity, like Bitcoin? Even worse, this is not a loan where we can put a maximum total exposure. If the position was loss making at $1 billion on Monday last week, it just doubled to $ 2 billion on Wednesday as the stock kept going up.

From a bankster’s point of view – they have a problem, and the problem is directly related to how much loans or margin they have extended to the hedge fund. Banks where risk management is king will give an explicit set of instructions to the Account Manager for the hedge fund: “Put up or shut up!“. That means that the hedge fund needs to put up an additional $500 million by the end of the day or they will close-out the position and the hedge fund, and their investors, will have suffered a loss. Not a paper loss. A real loss. The game is over for them.

Now what happens in banks where Risk Management is a humble stable boy in the grand scheme of power in the bank.

Here is where Risk Management would say something like this to the Relationship Manager  ”

Dear Ms. Relationship Banker,

Sorry to have to trouble you Ms. Relationship Manager, but we are of the opinion that this position of your client looks a little bit risky. If it is not too much trouble, could you consider to request your esteemed client whether it is possible for them to provide a little bit of extra margin, for our comfort.

Please don’t get angry at us or cut our bonus.

Signed..

Your slave,

Mr Risk Manager.

That is where the things become a problem because now the bank’s potential loss gets bigger and bigger, day by day, as Gamestop keeps on rising to infinity. Here is where we can begin to put in place the context of Reuter’s reporting of the $70 billion paper loss sustained by hedge funds.

Add to this another factor – the actual clients of these dirty hedge funds. You know the millionaires and wanna be Georgi Soroii who invested in the hedge funds, thinking that these money managers have some sort of magical powers. These folk may suddenly develop a sense of foreboding that something is amiss, and suddenly figure out that they are losing money – BIGLY.  It becomes a full scale bloodbath when the investors decide to exit these hedge funds at precisely the worst time for the bank, because it will force the bank to close the hedge fund position as the hedge fund needs to liquidate all positions to meet the investor’s request.

So in short, could things go even uglier?

We are not here to predict whether it will go uglier but to give you a sense of how an ugly picture looks like. It will be something like the Dow closing down 2,000 points next week and Gamestop shares keep on rising. If that happens, then you can understand the mechanics of what is happening behind the scene by referring to the article above.

Please note – we are not making any predictions, just giving you a mental model to understand things from another perspective. Of course, no description above is complete without mentioning the ultimate Kingpin – the Federal Reserve. Our view is that the Federal Reserve will eventually bail out all those concerned.

For readers who are more interested, read this post by Zero Hedge over here.

Now we return to our somber state as we mourn over Manchester United’s loss to Sheffield United and Tottenham’s loss to Liverpool.

 

Our initial view as of 29th Jan 2021

Now what made this extremely interesting and in continuation of our theme of the evils of Big Tech was what RobinHood, the trading platform favoured by millions of users did yesterday. They were reported to have blocked all buy orders on GameStop shares which caused the share price to crumble intraday, all in the name of ‘risk management.’

Come on man. Kind of reminds me of the song “I like the way you lie”

Shares are bought and sold on margin or on cash basis. If let’s say Game Stop share price was $100, a brokerage could offer a haircut of lets say 30%, and so fund only $40 of the stock with the investor having to put up $60. This means the loan is always well collateralized, and very rarely do we see loans on securities turning bad provided there is a degree of initial margin applied.

Our view is that the Wall Street sharks pounced on Game Stop  to short near the price of $400 which then drove the price down. At that time there was no buying volume because the Robinhood app had shut down the chance for investors to buy.

However, that action severely damaged RobinHood because its traders are revolting.

The question is of course, why did RobinHood do that?

The Financial Times reports that RobinHood did something very dramatic over the past 10 days.

Basically it

  • Raised $1 billion of equity from its investors
  • Drew down on a credit facility of several hundred million dollars from a consortium led by Goldman Sachs, Bank of America and Wells Fargo.

This is what the CEO said:

Wow – not only did Robinhood rewrite the rules of trading, they rewrote the rules of credit risk modelling as well. Not bad for a startup.

( Our view on 01-Feb 21 is that DTCC required 100% upfront on GameStop and Robinhood needed capital for the trade )

For those unaware of financial lingo, these 2 actions taken together can mean that something very bad could have happened to the Company over the past 10 days. Companies do raise equity, that is part and parcel of capital raising, but raising equity and drawing down on your credit line usually sends alarm bells ringing on any credit analysts rating review. The relationship between companies maxing out their credit lines and having a much higher likelihood of going into financial distress is a reasonably well established relationship in the field of credit risk modelling.

Ok – now to piece things together.

Did Robinhood or an affiliated entity hold a put position or a short position in GameStop?

Was Robinhood trying to save Citadel, an entity which shorted Game Stop and is responsible for 40% of their revenues?

If they did, was the action on limiting trading on GameStop a form of market manipulation?

Will the SEC investigate?

Does anyone care that Man United could not beat lost to a bottom placed team?

Ok – you get the drift.

 

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