“On Wall Street, a corner is not just an intersection of two streets. It is also a way to extract huge profits from speculators who had the temerity to sell a stock short.. In a corner, a buyer or group of buyers purchases a lot of stock. As the price goes up, short-sellers appear. They borrow stock - perhaps from the very same group - and sell it, hoping to make a profit when the price declines. Then comes the squeeze. The group, which now owns more shares than exist, demands the return of the borrowed stock. The only way the short-sellers can comply with that request is to purchase shares, and the only one who has shares to sell is the corner group. The group can set its own price and make a fortune. One reason you don't see many corners these days is that they are illegal in most countries. But another is that almost everybody involved tends to lose in the end, with the exception of lucky investors who happened to own the stock before the fun started and can sell into the big run-up in prices. Those who execute corners usually make lots of money from the short-sellers. But they end up owning a company for which they paid too much. The stock is delisted from the stock exchange, since, without enough public shareholders, there is no ready market for the stock. If the group that executed the corner used borrowed money, it may be in big trouble. In the 1920s, the most famous corner in the United States was in stock in Piggly Wiggly, a grocery store chain. The corner was successful, but the man who executed it eventually went broke. But there have been successful corners. Cornelius Vanderbilt once pulled one off, with members of the New York City Council as the victims. They had tried to profit by shorting a railroad company that Vanderbilt controlled, and then revoking the company's principal asset: a license to operate a street railway. Vanderbilt bought shares and kept the price from falling. Owning more shares than there were outstanding, he offered to let the council members cover their short positions with only small losses if they reinstated the license. They did. The big loser in that corner was a legendary speculator, Daniel Drew, who had proposed the idea to the council members. He was forced to purchase shares at very high prices. It is Drew who is credited with the saying, "He who sells what isn't his'n, must buy it back or go to pris'n." - ‘Porsche reinvents the short squeeze’, The New York Times, 30th October 2008.
Of all the flora and fauna within the cornucopia of investment and trading strategies, short squeezes are da bomb. And of all the short squeeze ventures that have occurred to date, that of GameStop is the equivalent of the Manhattan Project. Robin Wigglesworth for the FT takes up the story:
GameStop’s rocket-fuelled trading this month, which has taken the stock’s gain in 2021 to almost 1,800 per cent, is a vivid example of how a new army of day traders have “weaponised” financial derivatives to their advantage.
The game retailer’s stock had catapulted 135 per cent by midday trading in New York on Wednesday, to $353, extending a recent spree of gains that sent it zooming higher from its 2020 closing price below $19 a share.
One user with the moniker DeepF**kingValue on the popular Reddit forum WallStreetBets posted screenshots on Tuesday showing how he had turned about $50,000 worth of GameStop call options — which give the holder a right to buy a stock at a certain price, and function much like a leveraged bet — into nearly $23m this year. Yet GameStop is only the most visible example of today’s options-fuelled stock market mania. While the increasing use of derivatives has been a hallmark of previous retail trading frenzies — such as the late 1990s dotcom boom — the current popularity is alarming even seasoned observers.
“What we’ve seen over the last few trading sessions borders on madness,” said Steve Sosnick, chief strategist at Interactive Brokers. “You could always get crazy things going on in individual stocks, but when you see it metastasising through a whole range of other stocks, that’s a sign of real froth.”
Perhaps the most pathetic reaction to the absurdity of GameStop was evinced by the following Bloomberg tweet of 27th January 2021:
BIDEN TEAM IS ‘MONITORING THE SITUATION’ WITH GAMESTOP.
What, exactly, does the superannuated, demented old fraud think he is going to do ?
But the GameStop hilarity does not exactly reflect a financial market of any inherent, erm, stability..
As asset managers, we focus almost exclusively on trying to identify underpriced high quality investments offering compelling value. Although we don’t sell stocks short, we are, however, comfortable allocating modest amounts of capital to specialist traders who are willing, when appropriate circumstances prevail, to go short certain assets when the price momentum underpinning their valuation collapses, be that equity or bond indices, currencies, interest rates, or hard or soft commodities. (They also, of course, go long those same markets or instruments when the price momentum behind them is robust and positive.) The beauty of this approach, known as systematic trend-following, is two-fold. Firstly, systematic trend-following funds can, with some degree of confidence, be expected to offer zero or even slightly negative correlation to stock and bond markets. Which is desirable in the context of a properly diversified portfolio. Secondly, trend-following funds also offer the potential to generate strong returns even and especially when stock markets, for example, suffer sustained falls. Suffice to say, we gain some comfort from owning systematic trend-following funds as part of our diversified portfolios at precisely this point in 2021. Enjoy the party, but dance near the door.
Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: email@example.com.
Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and specialist managed funds.
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