Friday, January 29, 2021

The Devil Is In The Details, GameStop Edition

 The GameStop short squeeze (pump and dump, bull raid, call it whatever) is headline news so...

  1. When such arcane stories become headlines in the popular press, beware. It means the bubble is very popular and overinflated (aka who’s left to buy?).
  2. Such operations may seem novel, given the Internet and social media angles, but they are as old as the hills, including the “social media” angle. During the late 19th and early 20th century bull raids were routinely and intentionally leaked in newspapers and tip sheets in order to capture the greedy small fry speculators and thus complete the “pump and dump” cycle. Read all about it (and lots more) in Reminiscences Of A Stock Operator, originally published in 1925.
  3. When stocks become so wildly volatile within such a short time (Chart 1) brokers and clearing companies (essentially DTCC) have to protect themselves against the very real and highly increased  probability of “fails”, ie failure of a customer to pay for his purchase or to deliver the stock on settlement date T+5) (he has 5 business days from trade date). It’s not rare for a retail customer to renege if he has bought a stock at, say, $400 and two hours later it’s at $150 or vice versa, to deliver the stock. So, clearers will ask for additional intraday collateral from brokers who will then have to come up with the money immediately. This, in turn, means the broker will have to either (a) ask their individual customers for immediate cash (ain’t gonna happen, ever) or, (b) tap into their own cash and/or bank credit lines. In the case of the recent nonsense, we’re talking tens of billions, not chump change.
  4. Following along, will banks be happy to lend this extra margin money to the brokers? Trust me, they will not - the risk is just way too big that the money will evaporate into thin air. They may do it once to maintain their customer relationship (the broker), but they will do it under duress and only if provided with separate, high quality collateral.  And if it happens again, all bets are off: the margin “window” will close firmly shut, or the cost will be so high that it will be ruinous to borrow. This is exactly what happened in October 1929, by the way.
  5. Next step is to raise cash by selling out the customers’ stocks, which pushes down prices further, creating more margin calls, etc. Rinse, repeat.
  6. Customers accounts go into deep, unsecured debits which they cannot possibly or desire to meet, which means the brokers themselves are on the hook, and so they fail too.
  7. Dominos start crashing fast.  If one or two banks were stupid enough to keep lending margin money, they, too, will get swept into the hole. They will sell collateral to protect their margin loans... further dominos fall.
  8. The Fed will certainly step in to protect the banks by opening up the repo window wide, but that doesn’t mean the money will trickle down to the brokers. Quite the opposite, in fact: the banks will hoard whatever liquidity they get and will only lend against Treasury (or equivalent) collateral.
  9. We’ve seen it all before, and it always ends up the same way. Crash. 
  10. There’s nothing new under the sun.
  11. Addendum: the dominos are falling, huge margin requirements result in trade restrictions.

Chart 1


  1. Amazingly GME is back up again however.

    1. This huge volatility is poison for the market...

  2. Poeple will just change to buying options. If you buy a put, then the seller needs to buy the underlying as a hedge.

    Those short the stock are hoping to drive down the price, but I hate to think what their borrow costs are. 400,500% wouldn't surprise me.

  3. There is nothing new under the sun, thats why we are going past the sun to the moon!

    1. uhm... havea look at a model of the solar system, then maybe rethink that comment?