- A bunch of Reddit traders chasing a multibillion-dollar hedge fund out of the market is hilarious.
- But there’s something much darker going on here.
- It’s another Wall Street bubble scam — a tale as old as time, just add memelords and no-fee trading.
- This is an opinion column. The thoughts expressed are those of the author.
- Visit Business Insider’s homepage for more stories.
Look, I get it, what’s happening on Wall Street right now seems hilarious.
A bunch of amateur day traders on the Reddit forum (or subreddit) r/wallstreetbets are chasing a multibillion-dollar hedge fund called Melvin Capital out of the market by picking through its short positions and using their collective might to run those stocks up to astronomical prices. The most notable of these is the video-game retailer GameStop — you may have heard about it over the past few days. On January 12, the stock was priced at $19. It closed on Tuesday at $147 and was well over $300 a share on Wednesday.
These Reddit-inspired runs have been going on for months now, but only in the past few weeks have enough traders joined the fun. They have memes and sea shanties, and they post profit and loss sheets that show them making millions trading the same-day options that are pushing the price of this — and other stocks with significant short interest — higher and higher.
In a time when so many Americans have so little and a few have so much, I understand the allure of seeing this as a battle between David and Goliath. These traders have sold themselves as the little guys daring to duel with an oppressive system of hedge funds, market makers, short sellers, equity analysts — basically everyone who pushes the buttons and turns the knobs that make financial markets go.
But that’s not what they are. There are a few players leading the pack who know what they’re doing, and they’ll no doubt be out of the short squeeze before it collapses. Other people — a lot of people — will be led to the slaughter. What we’re seeing here is another classic Wall Street bubble scam, just with the very 2021 aspects of a merry mob of memelords and no-fee trading apps.
Memelords at the casino
A few things to understand: Short sellers are people who bet that stocks will go down. They are only about 2% of the stock market. And because of the mechanics of short selling, when they make a bet, they can lose more than the money they put down. They can lose and lose and lose.
This is what Melvin Capital is experiencing. Because of the size and nature of its short positions, it had to publicly disclose those shorts through the Securities and Exchange Commission. A handful of people in Wall Street Bets know enough about the game to pick through those bets and make Melvin scream. Family members of some of the short sellers in these positions have been harassed online by some of the Wall Street Bets folks.
While a bulk of these Reddit traders seem to be in it for the “lulz” or to make some money, causing pain seems to be a huge motivator for a not insignificant number of these traders.
Wall Street Bets is now trying to stampede over short sellers who are raising questions about the value of the collective’s pet stock, GameStop. Their crusade isn’t about the underdogs bringing truth to light and triumphing over the all-powerful winners. This isn’t “The Big Short” where a few misfits can see what the too-suave Wall Street greed frat can’t. They prefer to pick companies that have no prospects — like this sad gaming version of Blockbuster — where their size can make a huge difference.
Or as one Washington, DC, hedge-fund manager put it to me: “You show up to this argument with intellectual authority, and they show up with a baseball bat.”
It’s different this time, lol
The people running the Reddit show aren’t doing it to make a statement about populism. They’re using our current politics and market structure to execute a strategy. So if you’re taking part as some sort of damn fool in an idealistic crusade, you should get out while you still can.
Because of the way Wall Street Bets is pushing its pet stocks up — through options trading, a more complex method than just buying and selling shares — experienced traders believe there are a few of their own leading the crew. Tracy Alloway at Bloomberg has a great technical explanation of why what traders are seeing smells like one of their own.
If you want simple way to understand how the professionals see it, though, imagine that a stock is a boomerang. There are some people in Wall Street Bets who know enough about the geometry of the market to know the exact angle and speed at which to throw it to make it ricochet around a room without stopping. That is why these stocks are ripping up so high.
The experienced traders in this bunch also know there is a price to pay if you’re left catching that boomerang when it finally slows back down to the ground. They also know that there’s a hefty tax bill at the end of this.
That’s because these Reddit traders are in large part buying same call options that have become expensive because of demand. It is almost certain that they will be paying short-term capital-gains taxes on these transactions. It does not matter whether or not they cash out their gains. As one experienced trader friend of mine said — yes, these people could trade their book to zero and still owe thousands in taxes in April 2022 (or 2021 if they’ve been at this since the summer like many have been).
What’s more, any experienced trader will tell you many short squeezes eventually collapse spectacularly.
No one knows how long this will last. But for now, there’s a group of somewhat sophisticated investors online leading a horde of ravenous buyers, roving around the market searching for shorts to squeeze. This is like trading with the knowledge that at some point any number of stocks could be attacked by Attila the Hun.
And sure, maybe this time it’s different. Maybe the anonymous wise guys really just want these regular joes to make a buck, and the amateurs trading from home will win the day. They’ll get out before these short squeezes collapse, make their money, and they’ll keep it. Maybe no one will get hurt, even though none of this makes sense from a fundamental business perspective and it’s the definition of bubble behavior. Maybe for once, in the long history of Wall Street speculation, the house — or some of its wayward inhabitants — will not win.
But probably not.