GameStop

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I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market Reddit. You can intimidate everybody.

—James Carville, 1993 (updated by the JC, 2021)

In which the experts in the market got properly schooled by a bunch of daytraders. Acres have been spilt on this elsewhere, but the JC’s own hot takes are these:

First: everyone knows shorting gives you unlimited upside risk. But there is still this basic supposition that, okay, it’s theoretically unlimited, but practically? — c’mon. There are rational bounds to which no stock can go. Well, we now know this not to be quite so obviously the case.

Second: shorting a stock that is at the bottom of its range is a way more risky proposition than shorting one that is at the top. GameStop closed at $3.96 on 17 July last year. Almost a dead duck — business model fundamentally in the toilet. Yes: it looked like things could only go one way, but they didn’t have to go too far the other way to make a mess of your pretty face. This would have been different if the stock was higher in its range. If you have a billion dollars in cash margin and you put on a $5,000,000 short at different prices, the potential downside payoffs are wildly different.

Buy	Quantity	Peak	Margin	Implied Bust Price
$3.69	1,355,014	$469.00	$631,070,461	$701.10
$36.90	135,501	$469.00	$58,607,046	$7,011.00
$369.00	13,550	$469.00	$1,360,705	$70,110.00

We have also estimated the point at which a billion dollar fund (fully into cash!) would run out of cash to post margin (this is the implied bust price). The closer it is to the bottom — zero — when you short it, the more shares you can buy with the same money, and the more amplified is the effect should the shares tick up. Can we imagine GameStop going to 700? Super unlikely — but not out of the question. Can we imagine $7,000 though, or $70,000? What would Homey say about that?

Third: There is a hard practical limit to how far any short investor can let a losing short position ride. This is the ugly side of the limited recourse investment vehicle: you only have so many chips in the casino. As long as you can continue to fund margin calls, you can keep your position on and ride it out. But only as long as you have free cash on hand. Of you run out, no-one is going to lend more to you, however convincing your proposition. And raising new capital is the same as crystallising your loss on the position because it dilutes your existing investors into oblivion. The new capital will come in at the existing net asset value per share of the fund — your mark-to-market NAV per share is pretty much zero. Your new investors are going to require a helluvva lot of shares. And really, why wouldn't they just use their money to put on their own short position? As per the table above, that is a much safer bet.

Fourth: Fully-paid long investors — in this case the internet denizens and redditor day-traders — do not have this natural constraint. They are borrowing to invest; as long as they don’t need the money to pay their rent — which they may well do — they can sit indefinitely.

Fifth: The internet is a beast. It is one thing to hold out short interest against one guy — Bill Ackman’s short on Herbalife versus Carl Icahn is the signature dish of that fight — and there is it a case of who has the bigger pile of chips. But if you are shorting against a meme stock where everyone is blindly, stupidly, piling in because it’s cool to stick it to the man, or because some influencer on Insta told them to — you are fighting an unlimited hoard, ram-raiding the casino with a prettty-much limitless supply of fresh cash. You have a hard limit. The world wide webs doesn’t.

Sixth: The regulators are going to want to do something to someone. It’s hard to see how that could be some HODLer on Reddit. Nor the Hedgies: they were just doing the deep-state stuff all hedge funds do. A few market infrastructure players looked to be volunteering to take the rap by strangling long interest amongst the day-traders, while the lucky old deep-state-connected hedgies carried on with unfettered access (barring the short-tick requirement, which meant they couldn't 't short on a down-tick). But you sense the market infrastructure guys were acting out of the same good intentions that path many a road to hell: some little people are, eventually, going to get hosed here, and they were presumably intervening to stop that.