Today my twitter timeline was filled with tweets on hedge funds, Reddit, GameStop and Robinhood. I’ll briefly explain what all this is about before expressing my opinion on what went down.
A hedge fund is basically an investment company where investors come together to pool their funds and invest it into all sorts of financial products. More often than not, they employ high risk strategies (such as leverage) to increase returns on their investment. Melvin Capital is a hedge fund who has provided great historical returns through shorting stocks. Shorting a stock simply means you buy a stock with the anticipation that it will decline. If it does, you make a profit.
GameStop is a dying merchandise retailer for consumer electronics and video games who are listed as a public company. And Robinhood is a financial service company with a platform where people can buy and sell stocks, ETF’s and cryptocurrencies.
Melvin Capital decided to exercise put options and take a short position on GameSpot. The users of a subreddit called r/wallstreetbets heard what they were doing, and decided to buy the stock to drive up the price. Long story short, I don’t know the full details, but that doesn’t really matter.
Now depending on your exposure, holding a short position can wipe out your entire investment if the corresponding stock moves upwards. Enter Robinhood, who decides to restrict users from trading the stock in a bid to protect hedge funds.
- Wallstreetbets manages to push GameStop stock by over 1000% within two weeks.
- Melvin Capital closes position with billions of dollars lost (unspecified).
- Robinhood faces class action lawsuit.
I didn’t research the specifics. It may matter, it may not. But what mattered to me is how people responded to the event. If you want to understand the difference between put options and shorting take a look HERE .
Although I am satisfied with my followers as the majority voted correctly on this POLL , overall I found people’s reaction to this event quite funny. Those who preach capitalism suddenly became socialists overnight. There were outcries over how Robinhood blocked investors from buying GameStop stock and how the evil hedge funds deserved to become insolvent. Reports made way on how these companies were manipulating the market for self gain (shock). And wishful thinkers expressed how “the masses are waking up to the broken system” while the self righteous people seized the divine opportunity to announce how ‘it was time for a new holy war to bring evil down‘.
This is just another example that demonstrates how neurotic people respond when events like this go down. Some become overly hopeful that “good is overcoming evil” while others tear up over the unfairness and injustices of Wall St.
Here is what I think.
As a hedge fun, putting 70% of your fund into one investment is a very stupid idea. I get the rationale. With COVID accelerating digitization, the disappearance of brick-and-mortar businesses are inevitable. From a business investment point of view, it was sound investment strategy. It makes complete sense to exercise put options and take up a short position on a business with a bleak future to extract the most amount of value before it ceases to exist. But how it was executed was utterly incompetent and stupid.
If you’re going to make a risky investment of such magnitude, shut up about it. I still don’t think we entirely understand what the Internet is capable of. Bragging your bets is simply asking for trouble. This was very short sighted from the hedge fund. Melvin Capital left footprints and a track record of what they were shorting in the marketplace. Users of r/wallstreetbets identified what Melvin were shorting and began purchasing the stock at mass scale.
Damned If I do, Damned If I don’t
Here are some not so easy questions to ask if I am the one running a hedge fund (stupid enough to put myself in this position);
- Could r/wallstreetbets have sent out a liberating message in a more pragmatic manner? Why inflate the stock of a poorly performing company that will have no beneficial impact aside from a pump and dump scheme? Why not instead topple down banks engaged in fraudulent activities? There’s no shortage of them.
- If r/wallstreetbets are taking extreme measures to deliberately manipulate the market in order to bring upon my demise, will I have to take extreme measures to protect myself?
- Therefore, should I coerce trading platforms into blocking a trade to protect my short position from a deliberate attack? Why should I stop there? Why not coerce social media platforms to censor anyone promoting the stock?
I really like what r/wallstreetbets did. They sent out a message that declared the possibility of taking control from Wall St to Main St. But the stock they went after was pointless. The message would have had a much more powerful impact if it toppled down a company engaged in fraudulent activity. As for Melvin, if I was in their position, I would of stopped as many financial platforms from trading that stock and censored everything around it.
Because r/wallstreetbets were not buying that stock in good faith. They were deliberately pumping a stock that was worth nothing. GameStop company is poorly performing regardless. They declared war on my hedge fund and therefore anything is permissible. If coercing platforms to halt trading would lead to class action lawsuits, then that’s a cost I am willing to pay to survive. Especially when I have done nothing that suggests fraudulent activity and have made a profitable investment choice that will benefit my clients.
Am I going to harm people that are involved with the trade? Yes. But everyone is playing predatory here. It’s a zero sum game. I win I profit. I lose, I close doors. Everyone is manipulating and everything is rigged. No one that has touched that stock is innocent. Perhaps your average Joe who is a die hard fan for EB games will take a decent hit. But that’s collateral damage at a small scale on inexperienced people who should not be investing.
Hedge funds are not evil. There is corrupt people in every industry. Not many of my readers will agree with me here, but I think Robinhood blocking the trades on the stock was the right move. And given the chance and capacity, I would of have used all my resources to stop people from purchasing that stock. The price of this decision will be significant. But again, its a necessary price that needs to be paid to prevent insolvency of my hedge fund. It’s simply war.
Emotions Change You
You can’t be capitalism on your way up and preach socialism on your way down. You need to learn to be consistent with your character. This is just another case of 2008 financial crises. Only at a much smaller scale with the positions reversed. The 2008 crisis went down with greedy bankers playing stupid with mortgage backed securities while geniuses were shorting it through credit default swaps. Both sides accelerated the chaos. With this short squeeze, hedge funds were shorting a dying company while geniuses identified their position and decided to pump it. Both sides accelerated the chaos.
You disqualify from preaching your moral values when you decide to play the game.
The virtuous people who are outraged by the restriction placed on the stock are the same people engaging in the rigged market manipulation for their own interest. The only difference is, they are pumping a stock that is in fact worth nothing, which will attract more inexperienced investors who will end up collateral in the game. Don’t be so quick to point the finger at hedge funds using underhanded methods to try and protect their position on a investment decision which I think was absolutely valid.