Should retail have the option?

'It's like David vs Goliath out there.'

I jumped on a quick call with WallStreetBets founder, Jaime Rogozinski, earlier to get his take on what's going on.

Here is a depiction of the last week or so in .gif format.

It's been a constant barrage of 'WSB' popping up EVERYWHERE.

And, by the way, I made that .gif myself so if you don't like it then tough since it's the best I can do.

If you haven't heard of WSB (WallStreetBets), then you have most definitely been living under some form of rock...

But you may have heard of GameStop, Blackberry, NIO or other smaller cap stocks that have led to massive price increases very quickly by a bunch of self described 'autists' and 'retards' (their words, not mine).

And personally, I think it's fantastic.

Absolutely mental, since there's no risk management, but fantastic.

Here is what Jaime said in his book released last year...

The last sentence is absolutely true.

The whole passage is true...

Buy especially that last sentence...

What is the 'exploit'?

I've put exploit into quotation marks there since it's not really an exploit.

People have been doing this for years.

Here is an unbelievable article from one of my favourite finance chatterers, Jamie Catherwood.

Short squeezes and market cornerings have occurred for centuries, and you can take that evidence from Jamie's example of the Dutch East India Co.'s shareholder activism in the 17th Century.

So the exploit isn't really an exploit but more a show of force by a particular group of investors who come together at a specific time.

In markets, you can go long and short.

Long = to buy, and short = to borrow shares to sell because you think the price should be lower.

Both serve as valid functions of price discovery.

But we're talking about what a 'squeeze' is here...

Let's take the example of GameStop ($GME).

You can see circled that the current short interest is at 102%.

More importantly, however, is the short interest ratio, which represents the amount of days it would take roughly for all short sellers to buy back their shares.

Currently, that sits at 6.3 days with 71.2mm shares to cover.

Yikes.

Could say that the move isn't even completely done yet.

There's been another dynamic at play though, which is known as gamma hedging.

Most of this GME buying has been done in the form of calls, a derivative whereby a buyer of a call has the 'option' but not the obligation to buy the shares at a set price and expiry.

I'll speak about this more as the basis for my thoughts on the industry towards the end of this, but this has also driven the price higher.

Options are a derivative, and so the writer of the option (market maker) has to buy the underlying shares, sending the price higher as the delta of the option changes.

I won't reinvent the wheel by explaining the more detailed process, since it's been written about a tonne over the past few weeks, but here's an excerpt from this Motley Fool article.

This is one differentiator from past squeezes - the fact that we have far more options activity occurring than before...

And currently, retail are leading the way...

The Underdog?

Something else to add to the 'exploit' is how we communicate these days.

The age of the internet has allowed greater access for more people to online forms of communication, whether it's via social media, more traditional forums like Reddit or instant chat apps like WhatsApp or Telegram.

Reddit is naturally the key to focus on here...

If you haven't been on Reddit, it is one of the bastions of internet culture.

It's a place where the meme generation thrives; a pretty democratic (within reason) site, where people with similar interests (in this case buying YOLO -sorry, deep OTM - calls) can join a 'sub-Reddit' to discuss topics they like.

Good posts get upvoted, while shite posts get the downvote and become less visible.

In past years, these forums were more likely to be on private chat rooms, where there would be far more discussion, co-ordination and I guess, collusion between the participants looking to shift a market about.

It's more likely to be a bit secretive.

But secretive is not the case with WallStreetBets.

Here's their subscriber count over time.

And the forum's comment count per day...

Pretty crazy, right?

Here is another differentiator from past squeezes, even if they amount to the same mechanisms occurring...

It's that the squeeze is democratised.

The participation in markets from my perspective over the last year has been ridiculous.

TradingView, of which I am UK Growth Director of, was seeing 23,000 accounts added daily for a period of about a month last year, and in the latter part of 2020, even more retail traders piling on to take stock of the markets, taking us to 140 million hits per month.

We are now ranked 3rd in the finance and investing category of sites globally, above Bloomberg, Reuters et al...

So people aren't just looking at journalism anymore, but actively watching markets.

This probably has to do with there being little else to do in lockdowns to be honest with you, but still, referring back to Jamie's article, it's nothing we haven't seen before, just the participants and the way in which it is being conducted is a bit different.

In this currently context it really seems that retail aren't the underdog...

And the media, talking heads and institutions hate it.

With good reason?

Citron, the research firm famous for calling the monster short on Valeant, has been hit pretty hard by this (not monetarily, but maybe a bit of pride), but the stand out is the now bailed out and probably bankrupt-by-the-end-of-this-week Melvin Capital.

Citron's founder, Andrew Left, was calling for a short on GameStop at a few different points, and the Redditors absolutely blew him out of the water at every turn.

To be totally fair to Andrew, he has just released this video and I do like the fella a lot.

Melvin Capital I don't know enough about, but it's a hedgefund that initially was bailed out by Ken Griffin and Steve Cohen, founders of Citadel (I'm coming for you) and Point72, for $2.75bn...

And is likely now insolvent.

Yes, even after the bailout.

And the Redditors don't want to stop.

It really does seem that they want to pulverise short sellers as much as possible.

And some guy just made $22mm off $50k.

So no wonder the talking heads are hating this.

GameStop, a company which gives you 20c for a brand new game (probably) if you trade it in, is practically failing and is trading at $354 per share with a market cap of $24.9bn...

All because a subsection of the internet decided to come together and drive the price up?

If I had passed CFA level 3 and ended up getting my hedgefund bankrupted by a group who post rocket emojis and call themselves retards I'd be pretty pissed off too.

But there's a massive irony here because these people 'get' herd behaviour and the power of the masses.

It is a distinct irony that, on a macro level, the most apparently capitalist institutions and people, the asset managers, are getting destroyed by a group of traders who have unionised (cheers, @PriapusIQ) and used socialism against them.

Actually, that's bollocks, Ken Griffin's Citadel was handed $200mm of taxpayer money after the GFC... the epitome of socialism.

What do I see as being a problem?

This is the big question.

I see nothing inherently wrong with what has happened here with GME.

It's a market phenomenon that clearly comes around every so often.

No, what I see as being an issue is right at the beginning.

Technology, liquidity and information flow has improved to such an extent that brokerages no longer have to charge clients to take a trade.

Let's talk about Ken again.

Ken is a genius to be fair to him.

And really fucking rich.

He's done well and has been an innovator in the asset management world.

Where has has also been an innovator, is trying to find additional revenue streams and in the current context, something known as payment for order flow pops up (although it has existed for years).

If you have ever asked yourself how Robinhood can charge nothing to execute trades, this is exactly how.

Citadel control about 46% of the retail trading volume (i.e, they take the other side of retail trading activity by market making).

Retail flow is a market maker's dream...

They are taking the other side of traders who are not sensitive to price, who are uninformed.

In more complex terms, they are paying for flow which has less adverse selection risk, which enables them to keep a tighter bid/ask.

Citadel pays Robinhood 17c per 100 shares for flow, which is about a 19% premium vs other brokers like E-Trade, Charles Schwab etc.

Now we can focus back on the demographic of WSB users.

Young, undercapitalised (on the most part), using high leverage and are not afraid to just punt.

The majority of WSBers use Robinhood as far as I can tell, primarily because there are no trading fees.

Citadel are a high frequency trading firm, and their sophisticated algos mean that they can chisel away profits from this kind of retail flow, far easier than if it were coming from a buy-side firm with really smart people.

You will note that Robinhood has not entered the UK or Europe, and this is because payment for orderflow is banned here.

And it's banned under FINRA to single providers in the US since it goes against best execution policy too, which is why Robinhood had to settle a $1.25m lawsuit with FINRA over its best execution practices...

That doesn't mean best price, by the way, but can be subjective based on how quickly an order is filled, if it is aggregated amongst other things.

Now, I've looked at Wall Street Bets a fair amount over the years, more as a passive 'checker-inner'...

And I have seen more horror stories than successes, just like in any kinda trading.

It's the Pareto Principle right?

20% succeed while 80% lose, or 80% of the output comes from 20% of the inputs...

And we have seen blowups throughout history and will always see them...

The problem is that options are a complex product.

You can reduce Greek risks by hedging smartly, sure.

But many 'uninformed' traders won't be doing this.

No, instead their undercapitalised accounts and lack of fear surrounding margin calls will cause many to simply trade naked.

They're absolutely free to do that; I am by no means an authoritarian when it comes to what people want to bet on.

But I do feel that there is some burden there on regulated firms to at least provide full information as to where their orders are going, and how they are managed.

After that point, if people wish to keep dealing with the firm, that's on them - again, provide democracy.

But I don't necessarily see people caring.

Lack of initial cost is what matters, and is the instant draw.

In that respect, Robinhood have revolutionised the market as well.

On the call with Jaime, I mentioned that I thought Robinhood should charge a commission initially...

Jaime's reply was, 'that defeats the point of Robinhood.'

And he's absolutely right - if you want a more democratic system, then cost should not factor into things, as long as the full picture is provided.

It's been a mesmerising watch - and personally, I don't think this cohort are uninformed at all, I simply worry for those trying it in the future and getting burnt.