In the first installment of this two-part discussion discussing what is occurring in the netherworld of short selling, I discussed the mechanics behind a short sale. Now in the second installment, I will discuss what happened two weeks ago as GameStop (GME), AMC Entertainment (AMC) and other highly shorted stocks were under a massive coordinated short squeeze.
A group of traders, individual traders, those like you who are not affiliated with a large institution, such as a pension fund, hedge fund or mutual fund (note the common use of the term fund) who congregate on the social media platform Reddit.
These retail traders, contributing to a “community” on Reddit named WallStreetBets ascertained that several hedge funds were loading up on shorts for several companies, such as GME, AMC, Macy’s (M) and Bed Bath & Beyond (BBBY). Those short positions were so large that the Short Shares as a Percentage of Outstanding Shares (the percentage of stock that is issued and outstanding for which there is current short interest) was greater than 1 and in some case, much greater. As a result, those traders on Reddit were able to, legally I might add, launch a full-scale short squeeze on those short positions. This forced the short sellers to have to cover (unwind) their shorts at astronomically higher prices. The traders were happy because they were able to buy some of those company shares and flip them for a greater price.
I have to say that these traders were bright and deserved whatever money they legally earned. Funny enough, the hedge funds who normally feast on the individual investor class got their comeuppance as the tables were turned on them.
In Wall Street parlance, these hedge funds had their faces ripped off as the short squeeze created massive amounts of financial pain. One prominent hedge fund was Melvin Capital, who it is reported to have lost 53% of its capital just on these short squeezes, most of which was from GME. It is important to note that Melvin Capital was likely correct in shorting GME as the company is under financial stress. However, Melvin Capital made the mistake of not properly sizing its short position. As a result, it could not risk manage itself out of the short squeeze.
Citadel and Robinhood to the Rescue
In the incestuous world of hedge funds, many larger hedge funds seed small newly formed hedge funds. Typically, these new hedge fund managers were former employees of the larger hedge funds. In this case, Citadel LLC, the hedge fund, headed up by Ken Griffin anted up $2 billion and Point72 Asset Management, headed up by Steven A, Cohen, infused $750 million into Melvin Capital.
Robinhood is a popular trading platform, frequented by small investors who were attracted by Robinhood’s zero commission policy. It was designed to get young people involved in investing. As someone who has advocated investor education and getting young people involved in investing, I think that Robinhood’s intensions were noble. The Reddit Wall Street Bets crowd utilized Robinhood, for the most part, as their trading platform.
Robinhood made a unilateral decision to freeze trading in several of the short squeeze names, except to close existing positions. This decision clearly favored the hedge funds as it created a one-sided market where all that could happen is share prices could go down.
As it turns out, Robinhood can provide zero-commission trading to individuals by selling its order flow to market makers such as Citadel Securities, another firm controlled by Ken Griffin. By buying Robinhood’s order flow, Citadel get a first look at trades and can cherry pick what it wants to buy or sell before offering them out to the public.
Clearly, we have a conflict of interests. Robinhood reopened its platform to all trading but the damage was done to individual investors who may have been left holding long positions that precipitously fell. Robinhood is now a defendant in multiple lawsuits, including one on behalf of a 20-year-old trader who committed suicide. Furthermore, many of the players in this story are scheduled to testify to Congress.
Forget GameStop Its Marijuana Time
Now that the trade in GME and BBBY, etc. has calmed down, the Redditt crowd has turned to those heavily shorted marijuana stocks. Just yesterday, shares of Tilray (TLRY) surged nearly 51%. Other pot stocks also surged.
Should You Short Sell?
I remember, like my first kiss, my first short sale. I shorted 200 shares of Bankers Trust in the 1990s (likely 1998) and made a hefty profit. Not long after starting LakeView Asset Management, I had shorted Martha Stewart Living Omnimedia via stock and puts. I spent a considerable amount time getting grilled on CNBC by Jim Cramer, Larry Kudlow, and David Faber during the period that I was short leading up to her conviction. There were no other shorts who were willing to come forward. Even celebrated short sellers were long the stock. As it turned out, she was convicted, and I made some cold hard cash personally and for clients. I even appeared on Bloomberg Radio on the day of her sentencing to call color commentary on the proceedings. Please note, I covered my shorts the day before and went long. I also made money on that. Needless to say, the Martha Stewart episode helped to solidify my nearly two-decade long relationship with the financial media. If you want to hear the whole story, just give me a call.
Short selling is not as easy as it appears. For all my profitable trades (there were many others), I have had a few losses on the short side over the years. Here is what you should be aware of before you play the “dark side” and short stock:
1 – You must have considerable capital to be a short player.
2 – You must understand that losses can be infinite and be prepared for greater than usual volatility.
3 – Be careful to understand all the risks, including getting bought in if you lose a borrow.
4- If you want to short, do it small. Don’t be a hero.
5 – I warned you about the risks, so don’t blame me if you lose on a short trade.
Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was not long any positions mentioned – although positions can change at any time.
Scott Rothbort is the President & Founder of LakeView Asset Management, LLC, an investment advisor representative specializing in high net worth private wealth management. For more information on investing with LakeView Asset Management, LLC call us at 888-9LAKEVIEW or request more information by clicking on the contact button on the top right-hand corner of the website. LakeView Management, LLC is a Nevada LLC, with its principal office located in Henderson, NV and branch office located in Millburn, NJ
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