$GME, FED and portfolio update

observe the fight, follow the FED; portfolio +25% in Jan-2021;

You don’t have to trade $GME

I strongly suggest stay out of this $GME frenzy, but to observe and focus on more important issues and the bigger picture. This is not the religious fight against short sellers that you’re probably hearing. This is an idiosyncratic event when some poor risk management practice met with unprecedented retail investors’ abilities to buy options using their credit cards/stimulus cheques.

Facts/terms you need to know:

Short squeeze:

when short sellers buy back shares they are shorting, their buying action causes the share price to spike up quickly.

Gamma squeeze: 

When investors buy call options, market makers sell call options. To hedge their risk of selling calls, market makers buy the underlying shares, based on the delta of the call option -- this is called delta hedging. 

When the underlying share price moves, the call options’ delta change, market makers need to adjust the number of shares they own to match that delta -- this is called dynamic delta hedge. When share price goes up, the delta of a call option goes up accordingly -- this drives market makers to buy more shares to maintain delta neutral.

In the $GME case, given the underlying share price went up so quickly, market makers out of sudden had to buy a lot more shares in a very short period of time. 

As we know given the extremely high short interests and that retails are buying and holding, the supply of $GME shares cannot meet the demand of buying - this amplifies the buying of $GME and causes the price to spike up even further.

Citadel and Robinhood:

Citadel has two arms of business: Citadel Fund and Citadel Securities.

Citadel Fund is a traditional hedge fund business. It backs Melvin Capital, and might’ve shorted $GME themselves.

Citadel Securities is a market making business. It’s the single largest customer to Robinhood. Robinhood’s business model is to sell their users’ (retail investors) orders to Citadel Securities to receive kickback fees. Citadel Securities makes profit by fulfilling these order flows. 

There is no real need for front running here (which by law is illegal), they can simply make more profit by giving these retail orders worse prices, effectively the same thing.

Quick Yes or No:

Should short selling be banned?

No: short selling is a critical function of a free market. Short selling lets asset managers decrease their risk in an efficient way, and/or expose low quality or fraudulent business. Banning short selling will force investors to sell high quality assets, and/or less liquid securities in stressing periods, severely dampening the financial market stability.

Should $GME be short at 140%?

No: This event is ultimately about really bad risk management. No one should jump onto the short selling when short interests is this high - knowing the risk that there’s a fair amount of chance you cannot buy back the shares at a reasonable market price. 

To Melvin Capital’s particular case, no matter how strongly the original short selling position is convinced, once the running loss runs over a certain level they should’ve cut the loss and stick to their risk management rule (if there’ any). Betting against anyone in the risk of losing the majority of their funds under management is absolutely irresponsible.

Should I buy $GME now?

No: for 3 reasons:

  1. Part of the reason for the broader market weakness is short sellers, or funds with some kind of exposure to r/wallstreebet names, were taking profits of their winning positions to either 1) reduce the VAR or volatility of their portfolio 2) covering the margin call of their short position. My guess most of the heavy loss positions shorting $GME and $AMC have been covered.

  2. Many OTM calls of GME must be deeply in the money, further reducing the likelihood and the extension of a gamma squeeze. 

  3. Squeezes, particularly short squeeze combined with gamma squeeze are NOT likely to be a repeating event. If I were some of the hedge funds on the other side of this battle, I would start buying some OTM puts on $GME or $AMC to 1) benefit from the volatile price moves 2) balance the overall gamma exposure of the market makers, so there’s less chance of the huge gamma squeeze we’ve seen. 

As a matter of fact, looking at the chart below from Twitter, we can see the put gamma has been huge. After the big call expires, probability of price reversal is high.

This has caught enough attention to media and regulators -- keep fighting this “war” might incur undesired loss and cause unnecessary market volatility.

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Should I sell $GME now?

You can hold only if you believe the price reflects your expectation of its future fundamentals.

If you do have $GME: there is, nonetheless, an interesting way to take advantage of the currently very expensive $GME option prices.

Readers can sell covered calls (for every 100 shares, sell 1 call) to earn “very very very extra” income. For example, call options with 470 strike expiring on 19th-Feb can be sold for $125.35 or a whopping 35.6% premium. That's just 3 weeks away with a close to 600% implied volatility (almost unheard of). That means you get to collect the 35.6% premium as long as $GME does not move beyond 470 in 3 weeks time. Max payoff would be over 70% if $GME ends up at ~ $470.

More cautious readers can use the money from selling covered calls to buy puts, to limit your downside holding $GME. $GME’s calls are more expensive at the timing of writing, reflecting more demand for upside participation. It means if you sell a call with 34% upside cap, you can get a put to protect if $GME falls more than 25%.


FED

Central banks have shifted their main roles from policy setters to expectation manipulators, ever since Mario Draghi’s “whatever it takes”.

This week, unnoticed partially due to what’s happening to $GME, and contrary to many people’s interpretation, I think that Jereomy Powell starts to prepare to change the tune for a potential expectations/policy shift. This is super early, it might be a little overcautious, but it’s the start of the start.

After he reassured 

  1. the U.S. central bank was nowhere near exiting massive support for the economy during the ongoing coronavirus pandemic

  2. it would maintain its bond-buying program at the current pace of $120 billion of purchases per month until “substantial further progress” toward its employment and inflation goals has been made.

  3. it would take “some time” to achieve the threshold for altering asset purchases, making clear the central bank was not close to dialing them back.

  4. “The whole focus on exit is premature,” he said, noting that the U.S was a long way from a full recovery and the Fed would take care to communicate clearly -- to make sure no one was taken by surprise of what he promised would be a gradual taper of purchases when the time came.

He did also say that the widespread availability of vaccines were grounds for optimism, noting “several developments point to an improved outlook for later this year.” 

I believe that, it doesn’t matter how the FED reassures it won’t surprise the markets, the markets (especially bond markets) always always always try to front run the FED. Even this slightest optimistic sentence is the start of the narrative shift here. We’d strongly suggest everyone watch closely where the long end US 10 year treasury yield goes. When it gets closer to 1.5%, it would be a sign to be seriously cautious.


Portfolio Update:

For the first month of 2021, our portfolio has returned 24.84%, outperforming ARKK and broader indices. However there has been some intra-month volatility: the peak was reached around 22nd when the portfolio had a over 35% return and it gave back ⅓ of that performance as $GME started to take over headlines. 

Portfolio Details

We believe the recent broader market weakness could be an outcome of investors taking profits of higher beta names to reduce the VAR or their portfolio volatilities — ripple effect of /wallstreetbet.

A handful of positions had a particularly strong month, including 

$FUTU  +117%

$TCEHY +24%

$TDOC +32%

$FUBO +51%

Detractors include:

SQ -1%

BCOV -11%

And F +20% as we are short Ford.

This week we sold our $SHOP to fund more positions in $FUTU, $XPEV, $TECHY and a new $HMI position.

We believe $FUTU (a future fintech giant) and $XPEV (an overlooked AI & Auto-driving powerhouse) are massively undervalued to their great potentials. 

Check our article here on why we think Tencent($TECHY) is the digital Berkshire Hathaway, and a great diversified exposure to the broader Asian/EM tech and growth.

$HMI — we believe is a rare intersection of growth and value. Subscribe to see when we reveal more details of our analysis.

We also slightly adjusted our short positions, closing $COUP and $V, and opening $MA.

Stay tuned and good luck.