As the laptop-wielding video gamers turned day traders take their battle to the Hedge Fund Masters of the Universe, they need to recognise that the regulators are going to come in soon. Many appear to have got their education on trading from watching Netflix, whether it’s TV series like Billions or movies like Wall Street, Wolf of Wall Street or Trading Places, but in reality they look likely to meet another classic, Margin Call The most obvious move will be to extend the capital apartheid that exists elsewhere and shut down their access to leverage. The rationale will, correctly, be the use of Value at Risk (VaR) models to justify a series of margin calls. These models, incorrectly used to try and manage portfolios in the wake of the Global Financial Crisis, are correctly applied to leveraged trading positions in single stocks, which is exactly what the retail investors are running. A forced de-leveraging will break the ‘attack’ on the Hedge Funds and likely produce something of a rout in these names. The Fed will see it as a modest price to pay to protect the stability of markets.
The extraordinary antics of the RobinHood Traders and their battle with the Hedge Funds has moved to the front pages of the MainStream Media, eager for a new ‘Populist’ story to replace the void left by the departure of The Donald’. As a result the name of GameStop has gone from obscurity to mainstream and at one point this company, which was valued at only $250m this time a year ago, had become the biggest stock in the Russel 3000 by market cap. The fact that the stock concerned sells video games is particularly apostate given the age and profile of many of the Day Traders on the RobinHood platform, most of whom seem to think that stock markets can be ‘hacked’ like video games. Indeed ‘Cheats’ at video games are part of the culture and the same Reddit chat rooms that gamers have used for sharing cheats and hacks are now being used to try and hack the hedge funds.
However, the latest actions by the biggest trading platform, RobinHood, raise some awkward questions. After they apparently acted to effectively prevent individuals buying any more GameStop (while still allowing them to sell), questions have been asked about their relationship with the giant Hedge Fund Citadel and its billionaire founder Ken Griffin – the new pantomime villain of the piece as he sits in either his $100m London Townhouse, his $225m New York penthouse or on his recently acquire Palm Beach waterfront property. We know that Melvin, the hedge fund brought down thanks to the almighty squeeze on its short position in GameStop, was partly bailed out by the Citadel group as well as by SAC, owned by Steven Cohen, the (alleged) model for Bobby Axelrod of Billions. but also note that Citadel Securities (which is now the key source of Ken Griffin’s enormous wealth) is responsible for almost half of RobinHood’s order flow. There has been speculation in the past that large and powerful High Frequency Traders were effectively ‘front running’ the order flow from RobinHood traders ( Robinhood effectively sells orders to market makers ) and that the platform was more responsive to its big friends in Connecticut and Wall Street than to the ‘little guys’ that make up its ‘brand’. Given the RobinHood founders originally started out as High Frequency Traders this wouldn’t be surprising, although we would also suggest that their putative IPO may not be quite so hotly contested as it would have been a week or two back. Another WeWork perhaps? Certainly a plausible explanation for not accepting new orders in GameStop is the collateral Robinhood would be required to post on behalf of its clients to protect for Credit Risk to the exchanges thanks to 2 day settlement.
The Day-traders thinking that the Virtual Reality (VR) game of Beat the Hedge Fund is sustainable are likely in for a nasty surprise very soon and most likely the hit to VR will come from VaR, or the Value at Risk models used by institutional risk managers and, in times of distress, by regulators. While we regularly criticise the use of VaR models at the portfolio level for institutional investors, they serve a useful purpose at the stock level for leveraged traders – which is exactly what the Robinhood crowd have become. The higher the volatility, the more collateral needs to be posted by the broker and the less leverage will be on offer. The day-traders may have the numbers right now, but cut out their leverage and their power diminishes rapidly.
As well as margin calls, it is likely that the powerful hedge funds will also use the regulators to help. One obvious approach is the accusation of a Concert Party. When the senior executives of Guinness organised a group of investors to prop up the price of their shares – in order to expedite a takeover of the Distillers Group – the subsequent trial and prosecution was notable for two things; first the novel (and successful) use of Alzheimer’s as a defence for CEO Ernest Saunders, which led to the quip following his subsequent dramatic ‘recovery’ that “perhaps he forgot that he had it?”. Second, the use of the term “Concert Party” to describe the tactic of co-ordinate action to push up share prices. Leaving aside the fact that neither concerts, nor parties are allowed at the moment, this is the most likely route to be used by the big money hedge funds to try and stop the retail disrupters with regulation (as we wrote earlier this week, regulatory risk is the biggest threat here.)
But this isn’t just about David versus Goliath. Experience tells us to follow the money and there is usually an investment bank or two at the bottom of every ‘ruck’. We couldn’t help noticing for example that the list of the most shorted stocks on Wall Street – a ‘portfolio that has gone up 30% year to date and is hitting hedge funds across the board – is maintained by Goldman Sachs. And it would be highly unusual if they themselves were not ‘long’ this list before the Robinhood crowd were encouraged to join in. Similar, albeit lower key, moves by Prime Brokers to exploit their market knowledge of Short Positions have been the stuff of many a rueful conversation between wounded hedgies over the years, but this time it looks like the Robinhood ‘hackers’ have also seen the ‘cheat’ in the system. However, this looks like another doomed flurry of populism and the smart money is already backing the big money on this one.