How do you short 140% of a stock?
Reflections on the Attempted "French Revolution of Finance"
A: Theoretically, you can’t. It is like betting that 140% of a company will fail. But, in practice, apparently, it is possible. And it is only possible in a system that lacks both transparency and good accounting.
The stock to which I am referring here is Game Stop ($GME). With the $GME trade heating up again, I wanted to take a closer look at what happened with $GME just six weeks back, as it took me some time and effort to successfully understand it myself. In late January of 2021, $GME had a 140% short float. A short float is the number of shares short sellers have borrowed from the stock’s float. A stock’s float is number of shares of the stock that are available to the public. Some shares of a stock aren’t available to the public. So the total number of shares minus the number of private shares is the stock’s float. (For more on this see this website.)
But let’s back up a little further, though. What does it even mean to short a stock?
If someone believes that the price of a stock will go down, they might choose to “short” the stock. To do this, they have to borrow the stock from its owner and then give the stock back to the owner at some point in the future. The person who borrows the stock immediately sells the stock on the open market, believing that they will be able to buy the stock back at a cheaper price by the time they have to deliver the stock back to the person from whom they borrowed it. This process also requires margin and premium payments. Margin is the collateral that the seller puts up to ensure that you can reimburse the person from whom they borrowed the stock. The premium is a payment made from the borrower to the seller, usually every month, while the stock is borrowed. It’s a bit complicated, no? Probably easier to just forget about this and go back to watching the latest episode of The Bachelor.
So, in theory, if there is any amount of private shares of a stock, you would not even be able to short even 100% of the stock, yet, magically, $GME found itself with a 140% short float. Late last year, hedge funds like Melvin Capital were sure that $GME’s price would continue to fall, so they took a heavy short position on the stock. The pandemic was still raging, taking its continued toll on brick and mortar establishments, and most video games are purchased online via the video game consoles these days, so it seemed like a sure bet. Besides, who would think to start heaping money into the stock of a company that seemed to be quietly dwindling away? u/DeepFuckingValue, that’s who.
In November of 2020, Reddit user u/DeepFuckingValue decided that he was going to YOLO (“You Only Live Once”, which translates “I am going to throw a huge chunk of money at this stock and see what happens” on Reddit) $53,000 or so into $GME in hopes that its price would rise. This user noticed the massive short float and decided to bet against it. He publicized his trade in the Reddit chat room r/WallStreetBets, a chat room, notorious for its far-from-PC humor, in which participants share their trades, especially their YOLOs.
Before we get into what transpired, let’s address the question at hand: How do you short 140% of a stock?
I knew that this did not make sense, but I couldn’t conceptualize it logically. I listened for explanations on CNBC, Bloomberg, and other major media outlets, but it was not until I came across episode 26 of Pennies: Going in Raw, a podcast hosted by two day trading twenty-something-year-olds - Hugh Henne and Dan, Diety of Dips - that I found an explanation that made sense to me. From minutes 14:50 to 37:38 of the podcast episode, PJ Matlock - CEO of Atlas Trading, multi-millionaire, and high school dropout - explained what happened with “the GameStop short squeeze” more clearly than anyone in the mainstream media or with any fancy degrees had.
Below is a summary of Matlock’s explanation.
Shorting 140% of a stock includes four parties.
Trader 1 – Owns shares of GameStop; lends shares out to short sellers via their brokerage because they (the owner of the shares) plan to hold the shares long term anyway. They can make an extra buck in the form of a premium by lending these out
Trader 2 – Borrows shares from brokerage; sells them on open market
Trader 3 – Buys shares on open market; because of bad accounting, the buyer does not know that she is buying already shorted shares; now Trader 3 decides she is going to hold this company’s shares long term and informs her brokerage that she is willing to lend them out to short sellers who are interested
Trader 4 – Borrows the shares from Trader 3 in efforts to short the stock
Incredible, no? How is it possible that shares that are already being lent out to short a stock aren’t watermarked so that they cannot be lent out again?
So, because of what Matlock termed this “synthetic shorting”, the short float for $GME hit approximately 140%. Once more and more people in the r/WallStreetBets community began to notice this, they began to pile into the trade, buying shares of $GME with intentions to pump the price of $GME so high that they would liquidate the (evil) hedge funds that had shorted it. For these short sellers to get out of their position, they had to buy shares back, because, as mentioned earlier, they eventually have to return the shares to the person from whom they borrowed them. The higher the price went, the more impossible it was becoming for these hedge funds to buy the shares back. And it wasn’t just the r/WallStreetBets community that noticed this. Michael Burry of The Big Short fame took a massive long position (bought many, many shares of $GME, believing that they would increase in value) on the trade. Even the real life Wolf of Wall Street, Jordan Belfort, got in on the action.
This was kind of like the equivalent of being able to go in on a heist with the real life Henry Hill from Goodfellas. Really exciting stuff! And then we had some profound commentary from yet another class act - The Mooch. Anthony Scaramucci (Yes, the same guy who served as White House communications director from late July 2017 until late July 2017) chimed in with the following:
If the price of the shares of $GME went to the moon, not only would these hedge funds be liquidated, but the entire plumbing of the financial industry could have dried up. According to Raoul Pal, former Goldman Sachs trader and CEO of Real Vision (an incredible platform for financial literacy), banks had begun to call the financial institutions that had shorted $GME, asking that they put up more margin. In efforts to do so, these hedge funds had to begin selling their blue chip stocks. Had this continued, it would have rippled throughout the industry, causing a potential collapse in stock prices. The plebs had turned the internet into a decentralized hedge fund, and the had the bad guys against the ropes. (To better understand the levels of vitriol involved in this “protest pump”, I recommend reading this letter.) By January 27, 2021, the price of $GME was headed sky high, and hedge funds like Melvin Capital were feeling real pain. They were down billions and were on the verge of losing billions more. It was a beautiful thing. And, then what happened?
Perhaps the most ill-named JV-ass company that ever existed, Robinhood, cancels the buy side order of the $GME trade, only permitting its users to sell, and, in some cases, auto-selling for its users. Other trading platforms followed suit until the price of $GME receded. Major media outlets claimed that financial institutions like Melvin Capital had gotten out of its short positions (though, some claim they hadn’t/haven’t and that the mainstream media was simply trying to make traders believe that they had so that they would stop trying to pump $GME). Fury ensued amongst retail traders (non-institutional traders, like those in the r/WallStreetBets community), as the system had flagrantly changed the rules in the middle of the game. I can go on and on about the complete and utter lack of justice here, but it is a bit beside the point of this piece. For now, I will leave you with a few lessons learned from this debacle.
Bitcoin (the blockchain) has the potential to fix this; had the lending, selling and buying of shares of $GME been on the blockchain, a public ledger, funds could have been watermarked. This could have stopped the same shares from being sold to multiple short sellers, hence, stopping the formation of the 140% short float
We exist in a capitalist system only when it is beneficial for the powers that be; when those powers that be begin to lose money en masse, the rules change; if you ever here someone from the financial industry extolling the virtues of “free market” capitalism, stop listening to this person; the traditional market AKA the “boomer casino” is as “free” as the powers that be want it to be
Delete your Robinhood account; vote for justice with where you invest your money and with which platforms you share your data
This “Gamestop short squeeze” might only be in its initial phases; some claim the short squeeze will continue (Thanks for the source and info, Sarah!)
Consider investing more of your money in Bitcoin or other reputable cryptocurrencies. We know the traditional finance system is rigged against the little guys and gals; opt out, and join a more transparent financial system. You can even invest in Bitcoin IRAs these days
Props to everyone who held the line and didn’t sell their shares of $GME. While I am skeptical that this will play out in any sort of way that will be financially beneficial for holders of $GME, I respect your conviction.
Best,
Frank
Find Me on Twitter: @frankcorva
What I’m Currently Reading: “The Sovietization of the American Press”, by Matt Taibbi
What I’m Currently Listening To:
“…you never know you’re never ready / but all your fear is just confetti / let it blow all ‘round your bedroom / when it gets too heavy / don’t let it get too heavy” -Kevin Devine
Nice one - Love the Wolf of Wall Street make-over
Can’t wait to watch someone making a movie about this “GameStop short squeeze”!!