In the past month a group of minnon sized investors managed to rock the financial world, change history and almost kill a whale investor. This is how wallstreet bets could one up on wallstreet, and if you read on it might give you clues as to how you could to.

Disclaimer this is not professional financial advice and readers are encouraged to conduct there own research before making and acting on any decisions, BecomeaBarrister and its affilates are not responsible for the decisions or actions of its readership.

The Simple Explanation

The first thing to know about wsb did is that it was not investing as most know it to be, that is buying a share in a company or selling a share in the company. Instead, what they did was place a bet. To explain the process in simple terms, the group found a stock where not many shares were available, where it was artificially low in price and had been oversold, they noticed that if they performed what in the business is called a ‘short squeeze’ due to the timing of the bet it would cause the company they made the bets with to increase the price of the shares and if done quickly enough would force those betting on the price going down to ‘lose their shirts’ i.e. have there position closed in a loss. Further, they had noticed that if this happened nothing would be able to prevent the price from going up. They then did this repeatedly and for 1 month they could not be stopped.

The Process Explained:

To explain what has happened with stocks like gamestop, a month ago some people on the reddit group wsb noticed that Citron, a hedge fund whom make money by ‘shorting’ the market (i.e. making a bet that a company will be worth less in future) were shorting gamestop. This alone would not draw much attention, what did was how much they were shorting it by, which was 140%. An amount which far exceed the normal range of 50-70% and left the company exposed to a short squeeze strategy. To explain how the strategy works I have to explain what shorting involves.

With shorting, what you are doing is agreeing to sell a stock to a buyer at todays price, however, you do not actually own the stock yet, your plan is to buy the stock when it is cheaper with an agreement already in place to sell it for more. To give an example I offer to sell my fist friend a bar of chocolate for £1 and he agrees, but I do not have the chocolate so need to find someone who does, so I look for friend B who is offering to sell a bar of chocolate for £0.8 – I accept then sell the bar to my first friend in the process making £0.2 in profits, which is the difference in price. Now of course the alternative might have happened, the bar of chocolate could have gone up, as shares can rise more than 100% and if that happened I would lose all my investment. If the price had gone to £1.2 for the chocolate then it has the effect that I am trading the shares to the buyer for £1 and having to now pay a premium in order to buy them and sell them to him at his lower price. At present, to prevent risk sell side behaviour the US has a rule that leveraged positions (all sell positions are leveraged positions) must have capital in place of 100% of the bet and an extra 50% to cover the 100% bet for a total of 150%, if it exceeds that then the seller must add more capital to reduce the percentage or close in loss.

What Citron had done was held a very large position on Gamestop that was 140%, meaning it was barely in profit. Rather then doing the prudent thing of taking a profit and closing the bet a few months earlier when Gamestop was at $2, they had waited the stock rose to $12 creating a precarious situation where if they existed they lost billions so they stayed in the game and had invested more. What wsb realised is if they increased the price of Gamestop by a large enough percentage, it would either cause Citron to close its position or to inject more capital to cover the loss with both scenarios causing the price to rise.

Both results are important as if they close in loss because Citron had very larges amount of sell positions this would remove sellers on the stock and cause it to rise as there would be no price resistance, this in turn would bring in more buyers. If Citron instead injected more capital it would force them to buy more shares at a higher price to place for sell further locking in losses with the hope some of the buyers will turn to sellers. Yet, this plan fails if you run into a situation where the market remains illogical longer then you can remain solvent.

How wsb manipulated Citron and the stock was to take out options in mass. Options are different from shares, with shares if there are only a limited number in circulation that can be buy then you have two options, either make an order to buy the shares at a price and hope they are sold to you or leave an order to get the shares at the price available on the market. The first option makes it hard to buy shares meaning while the price increase you do not gain much benefit if you cannot secure your position. As for the second option, that means you are forced to buy at a higher price and again limiting possible profits. These dilemma do not exist however, in options trading, so you can place and receive a bet at ‘spot’ current prices. However, if you place a buy option the market maker who sets up the contract then has to buy the actual shares to hedge against a reversal.

And so, the manipulation took place, record numbers of Robinhood investors piled into buy options on Gamestop creating a massive influx of trading volume for buy orders and at the same time locking in their positions. The market markers were then forced to buy shares in an other illiquid stock on mass leading to massive buy orders that could not be filled but had to be filled resulting in the price of shares ballooning in price. Then a number of investors noticing the change in direction took on leveraged buy positions further accelerating the outwards trend. Then as momentum grew more and more people joined the journey outwards destroying hedge funds in the process.

And, that is in essence how wsb got one up on wallstreet.