Punish the Short, and Spinach

For the short, I refer, of course, to the short seller. Most, by now will be aware of Gamestop as a company. It makes and sells videogames, and its share price was something like $US19 before a certain hedge fund decided to short it.

First, to understand how a short works. The shorter borrows shares and has to pay some sort of fee to persuade the owner to lend. The shorter then sells the stock, and at a later stage has to repurchase, to return the “borrow”. You can make a lot this way if you handle enough stock, but also lose a lot, and to load it in your favour the short should involve a very large amount of stock. When that floods the market with unattractive stock, the price tumbles because who wants to buy so much? Then, the critical step: many other reef-fish who hold the stock panic and sell. This is needed because if nobody did anything, the price would go back up, and maybe higher when the repurchase was needed. The short works only because it persuades others it is time to sell and take a loss. If it works, shorter rubs hands and gets seriously richer, however when things go wrong, the loss is unlimited because the repurchase is required. 

So, the hedge fund bet big on Gamestop, and expected the soft market to fall, the reef-fish to try to cash out, and the hedgie to make big. Not much risk, because how could such a feeble company’s stock rise in price? Actually, fairly easily, but to understand that, we have to consider a relatively new phenomenon: the low-cost stock-trading platform. Once upon a time stock had to be purchased in packages of so many, and because bits of paper had to change hands, you usually had to find a buyer and seller prepared to trade the same number. If stock were in units of a dollar, not a significant problem, but some stock now come in units that cost a hundred dollars, which would put stock trading in the hands of the rich. But now we no longer deal with bits of paper; it is all handled electronically. That allows the low-cost trader into the scene, where people can even put up $10 and purchase a fraction of a unit share.

Now we see what went wrong, at least for the hedge fund. A huge number of gamers heard about this and plunged in, purchasing stock. This action from so many pumped up the price by factor of 20 in the middle of the short. These guys were not there to make money; they were there to punish the hedge fund for messing with the company that made their favourite games. They could all well afford to lose $10. Now, how much the hedge fund lost depends on how much stock they were betting with. Thus if they thought they would make a large amount of money if the stock price was depressed by a dollar, see what the loss is when you multiply that amount by 380.

There has since been a big commotion, urging the authorities to stop this “market manipulation”. After all you have to protect the rich on Wall Street. If they get it right, they win big; if they get it wrong, “Bail me out!” appears to be the cry, then if they are bailed out they pay themselves big bonuses for being so clever and continue on their previous ways. Perhaps I should add, I have no problem with short selling. It is a bet, BUT there must be the condition that if the bet loses, the loser pays, not someone else. As for market manipulation, where is the manipulation in advice to “buy this now” and give reasons why? What is different from the average financial advice from the big boys? It is quite reasonable, in my opinion, to buy stock in a company that makes a product you like to avoid it being taken over by some pirate company, be broken up and the assets sold off just to make someone a lot of money. If you are prepared to lose money to keep a company alive, what is wrong with that? They protest too much.

There is another problem with the protests by Wall St.: where does the shorter borrow the stock from in the first place? The easiest source is these new platforms. When the ordinary guy buys such stock, it is the platform that actually possesses it, and the platform can make more money lending it out. Without the small platforms it may not be that easy to purchase enough stock to be worth the effort, so these platforms are needed by Wall St. Regulating the small platforms just to favour Wall St will be very messy.Finally, something totally different. I came across an item in a newspaper that started with, “Spinach sends email”. You might guess this is wrong. What happened was it turns out spinach is surprisingly sensitive to certain soil contaminants, including certain nitrogen oxides. What happened was a camera detected the change and sent an electronic alert. But wait, there’s more. One of the proposed uses was that spinach could detect landmines. Yeah, right. I can just see everyone walking over land, digging it over, then planting spinach to see if there is a landmine below. They would probably know when they started walking over the ground while preparing it.


3 thoughts on “Punish the Short, and Spinach

  1. Short selling is extremely dangerous to those who sell short. On the face of it, it should not be unlawful. However it should be open to… everybody. Other financial strategies used by financiers of the Democratic Party should definitely be unlawful: high frequency trading, especially when leading the markets. Let me explain.

    In short selling, the seller opens a position by borrowing shares, usually from a broker-dealer (who is distinct from a market maker; Robinhood is such a broker-dealer; Citadel, which gave 810,000 dollars to the ex-Fed Chief and present Treasury Secretary Janet Yellen is a market maker… and also a hedge fund). The short seller tries to make money by selling, at a lower price, those shares it borrowed from the lender.

    To open a short position, a trader must have a margin account, and only high worth entities can do this, considering the dangers involved, and will pay interest on the value of the borrowed shares while the position is open. As usual, the Financial Industry Regulatory Authority, Inc. (FINRA), which enforces the rules and regulations governing registered brokers and broker-dealer firms in the United States, the New York Stock Exchange (NYSE), and the Federal Reserve have set minimum values for the amount that the margin account must maintain—known as the maintenance margin.

     If an investor’s account value falls below the maintenance margin, that’s a margin call: more funds are required, or the position might be sold by the broker.

    Selling short can be costly if the seller guesses wrong about the price movement. A trader who has bought stock can only lose 100% of their outlay if the stock moves to zero. However, a trader who has shorted stock can lose much more than 100% of their original investment. Having invested $10,000 in a ten dollar per share stock which shoots up in seconds to $100, one will lose one million dollars. The risk comes because there is no ceiling for a stock’s price, it can rise to infinity.

    Short selling is not necessarily toxic: it can uncover crooks, or wildly exaggerated stories, such as Nikola, an electric vehicle company which claimed to have mastered technologies it does not have (after short sellers destroyed it, serious car companies discovered they were right, and ended their collaborations with Nikola). However, telling lies and conspiring to lower a stock price, as many short sellers have done, should be, and is illegal (this is the Wolf of Wall Street story, as related in the eponymous movie).

    The real problem is that not everybody, but only a fraction of the top 1% can invest in hedge funds: that’s sheer inequity and inequality.

    Reforming the financial market should aim at more equality and equity, and thus, to enact them, more transparency.

    In particular high frequency trading, especially in connection with leading the market, should be made unlawful. However entities which became immensely wealthy and powerful so doing are the greatest donors to President Biden.

    I am advocating to open participation in hedge fund and short selling to all citizens… And that can already be done through some types of (new) ETF… However that does not mean that hedge funds that can collapse because of imprudent positions should be tolerated by the financial authorities: they should not. Nor that does it mean that I will do more short selling myself: my life is already dangerous and complicated enough…

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