Shares of GameStop (NYSE:GME) and some other heavily shorted issues like AMC (NYSE:AMC) saw big gainers over the past 3 wks as brigades of small retailer investors aligned and hammered Wall Street money managers that borrowed and bet against the stocks.
The Big Q: How does a money manager profit from a stock’s decline?
The Big A: Simple, the professional sells borrowed shares, when/if the stock tanks buys them back on the open market and return the borrowed shares to the lender. So, if the price sold is less than the price bought money is made on the trade.
But, an investor who is short a stock loses money when the price rises because the trade must be covered by buying the share at a higher price. This buying can drive the price North, forcing even more buying, creating a price effect known as a short squeeze.
That is what happened to several money managers this wk as companies they had bet against like AMC and GameStop began to rise. They were forced by their compliance officer to cover, aka “squeezed” out of their short positions
Now come some really savvy players that knew they enhance the action this by putting on a “Gamma Squeeze.”
That involves a whale/s piling into way out of the money Calls that allow for investors to buy shares at a set price, betting the price will rise above the strike price.
The dealer who sold the option would ordinarily buy some underlying shares to hedge the position, putting more upward pressure on the price. And as the price kept climbing, dealers had to buy even more. The Gamma Squeeze comes on.
The aligned brigades’ of retail Gamer investors did not invent the short or gamma squeeze. Those are long time efficient market strategies. But it was the 1st time organized retail investors had carried out such a move and hammered some big Wall Street players.
Thursday, many of the major online brokers restricted some trades in the stocks that had run up so much earlier in the wk. This was largely a reaction to higher margin requirements imposed by the stocks Key market-makers and the The Depository Trust & Clearing Corporation (Cede), the company that clears all stock trades. The operations of these companies are somewhat mysterious and complex, so the brokers did not explain why trading was restricted. To a lot of investors it looked as if Wall Street was striking back by limiting their ability to trade. The issues got fixed and trading reopened Friday.
The next Big Q: Who makes the really big money in this scenario?
The Big A: Stay tuned…
Have a healthy weekend, Keep the Faith!