$GME: Time to go whale hunting! Who is short the shares?

The question that keeps coming up is “how did we get to a short interest of 100% of the shares outstanding in GameStop?” This is freak wave stuff in capital markets and these issues can be resolved a) very violently (like Volkswagen) over days in 2008 or b) can grind out (like Tesla) over 6 months like March to September this year.

How is this going to play out? When you start seeing extreme positioning like this, crazy things happen. Shares don’t go up 1x or 2x. They go up 5x. Volkswagen went from 200 euro to 1000 euro and Tesla went from $100 to $500 (before the stock split)

All 3 of these short squeezes may have something in common – the options market. Lets get into some technical detail on what has happened here

Let’s get into the technical detail…

Volkswagen was Porsche trading options to gain control in the murky world of European over the counter options trading (2008) and Tesla was hedge funds shorting using put options (afraid of the short squeeze, and rightfully so) and hedging Tesla convertible bonds. As we will show, when option interest becomes a high portion of market caps, crazy things happen.

$GME: The bond market panic in March 2020

The bond holders: Come March and COVID, if you were a bond holder or lender to a physical retailer and lockdown imminent – you panicked, big time. GameStop bonds went from $100 to $70 (Chart 1). Recovery rates on a default with a retailer and a lot of store leases would not have been pretty. There was no credit default swap available to hedge your bonds or loans. What did you do? You called a bank and you bought put options (Chart 2) and a lot of them.

The hedge funds: It actually looks like in this initial period of March/April short interest fell as probably the HF short sellers possibly booked profits. However, bonds recovered and Moody’s upgraded and GameStop started to rally. The sell side analysts were all saying this is overvalued and a sell. The short interest is high, what do you do in a fund? You buy put options (the Tesla rationale)…so the open interest goes up even more..

Conclusion? Banks sold put options to the lenders and the bank traders had to short shares to hedge that. Banks sold put options to the hedge and those that had to be hedged. Also, banks have lent shares to the HF’s to short.

As the bonds and shares have rallied through the summer, more put options have traded and short interest has continued to increase to the incredible number we have now of 100% of all shares are short.

Chart 1: The Bond market panic. GME bonds collapsed from $100 to $70.
Chart 2: Put Option Open Interest last 12 months – started building from April to October. As Put positions were opened, short interest has grown

How many put options have been bought?? An insane amount…

Why? In March and April you had a a company with a tiny market cap of $250mn and $1bn of long term debt. So the amount of put options required on a small market cap (to hedge a bond default) was significant. Below is the put option open interest (by number of open option contracts) versus the share outstandings. We have screened this for all US stocks with put options. The GameStop (and Tesla) put option position relative to shares is off the charts.

Where are we today? It’s a massive game of chicken with the banks….

So now we have the active long holders sitting long. We have ETF holders that have to buy when the shares rally (they are passive). These large holders add up to 70% to 80%.

On the other side of the market you have hedge funds (possibly short via put options like Melvin Capital) and banks having hedged option positions and lent stock out.

Who is going to budge?? We have the 13-F in November for the quarter end holding. I don’t think the active longs are going to sell coming into a console cycle.

Banks are sitting there short 68mn shares to hedge funds and to hedge option position. Meanwhile in the background, we have a management team pulling levers, consoles launching and a retailer trying to move from pure physical to a share of digital. See our previous post as to how $GME could be worth $44.

Who is going to blink first….!

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