Stop Blaming the Suits.
A brief explainer on the Game Stop price surge, anger, and my take on where to go from here.
The Definitions
Short: You think a stock is going down, so you borrow it from a broker (leaving them more money than the actual purchase as insurance, called the “margin account”) You then sell the borrowed stock, waiting for the price to go down. Once it does, you buy the stock this new lower price, and return them to the broker you borrowed them from, minus the interest you had to pay to have that margin account. You pocket the difference between the original price and the price you returned them at (less margin interest).
Option: Options allow you to “reserve” a specific price (strike) and time to buy (expiration) a stock at. The cost of placing one of these “reservations” is called the premium, and just like with betting, is priced according to risk. The big difference with options is that they are much cheaper than longs/shorts and incur less risk as you’re not buying the asset, you’re buying the ability to buy it. These are created by market makers buying the stock to create options. They buy certain amounts of stock based off of risk tolerances.
Suits: Institutional Investors, hedge funds, investment banks.
r/WSB: Reddit forum called Wall Street Bets. They hate Suits and trade on Robinhood and other small retail brokerages.
Brokers: They handle all the transactions in the background. Most Suits know theirs and use real people. Retail Brokers (ex. Robinhood) have less of a connection to the traders that utilize them.
The Story
To begin this saga, 71.2 million shorts were placed placed upon the Game Stock (GME) as of the beginning of January. (Because shorts are based around loans, there were more shorts than actual shares, which there are currently 69.7 million of). These shorts, done by Suits, drew the attention of r/WSB. Hating the Suits, r/WSB performed a short squeeze, where you buy a stock that is heavily shorted, sending up the price. When this price increases, the Suits were pressed by those who lent them the original stock to buy some GME to make sure they could return the shares they had shorted. This sent the price up even more, leading to a relentless upward cycle.
A similar trend was happening with options. So many upward options (calls) were placed upon GME, that the market makers had to buy more GME to guarantee they could pay the people who placed the options. This caused the price to go up again, and we got another endless upward cycle in price.
If you want a deeper explainer on this , check out this article by the always excellent Matt Levine
And that’s where we were on Wednesday January 27th. In the course of fifteen days, the price of a GME share had gone from $19.95 to $347.51, an increase of 1642%. That’s absurd. r/WSB had sent their Saturn V rocket, GME, to the moon.
Then the crackdown occurred. Mainstream social media got wind of this movement by Tuesday, and by Thursday it had reached a fever pitch. Because the price of GME had so rapidly increased, many of the brokers that serve r/WSB decided to pause the ability of their traders to keep buying GME stock, limiting their customers to sell only.
Why? Well, when carrying out trades, brokers use a clearinghouse. With all trades, clearinghouses require the broker to post collateral for the stocks being traded. This collateral is based upon price movement and trade volume. At the maximum of the GME fever, Robinhood could not rationally post enough collateral to allow buys of GME without sending their entire business underwater. The volume was about the same as when we began the Covid recession, and the price movements were even more extreme.
At this point, not able to buy more GME stock, many of the retail investors began crying “market manipulation”. They believed that their retail brokers and the Suits were in cahoots, stopping them from buying more of GME so the price would go down. Not knowing the operational order of the market, their idiocy led them to blame others. This trend quickly moved to the political arena, with both sides of the aisle tweeting that they would “look into the situation”. In effect, the idiocy multiplied almost as fast as the GME stock price.
My Take
The irony here is that this regulation was put in place after the 2008 financial crisis withthe Dodd-Frank Act to assure stability to markets and to make sure the “Suits” couldn't speculate beyond reason. After the cause of the cataclysmic “no-collateral” environment of the 2008 recession was traced to over-speculation and a lack of collateral, the regulators smartly decided to make sure if an investor wanted to do something in the market, their broker had to back their idea with some sort of collateral.
At the heart of this lies a question of paternalism vs liberalism. Do we let people make any movement in the markets they want to with no overview, training, or certification? Or do we assure that people who choose to invest their wealth in markets know how markets operate, and understand the associated risks? America has always balanced the two, erring many times. We allow for relatively easy gun purchases, but high levels of licensing to drive a semi-truck. We used to allow you to easily take out a mortgage, and let funds speculate on those same mortgages, and we all know how that went.
What to do? Do we try to fundamentally change investment regulation to make sure only the “educated” can trade? Do we deregulate the system so everyone has an equal chance to lose money? I err on the side of risk protection. Humans are inherently dumb. It sounds very caviler to proclaim you should have the ability to lose all your money on investments you don’t understand, and if you brought that attitude to the rest of the world, you’d quickly find yourself broke, dead, or in jail.
So, go ahead. Limit the amount of speculation retail investors can do. Reprice call options to be more expensive. Put in more volatility caps. In the end, people who want to risk their money will get the training and means to make highly speculative trades. Risk will no longer be hidden behind “stonks only go up”. Rome wasn’t built in a day, and neither should the full democratization of investment.
