E19: Robinhood's GameStop decision: Why did it happen and how can it be prevented in the future?

I'm going all in with your beak, with your beak, with your beak. Besties are back. I'm going all in. Let your winners ride. Rain Man, David Sack. I'm going all in. And it's said. We open sourced it to the fans and they've just gone crazy with it. Love you besties.

Queen of Kinwad. I'm going all in. Hey everybody, welcome to the All In Podcast. It was a slow news week, so we decided we'd give you a special episode. We're going to go around the horn with our special picks. We're each going to pick three picks, everybody. We're going to pick our favorite recipe, our favorite new hobby, and our favorite streaming guilty pleasure because there was no news with us today.

The dictator Chamath Palihapitiya. Rain Man, David Sacks with his new track from Young Spielberg. Just ripping across the charts. Young Spielberg at it again, this time with a track focused on the Rain Man himself and the Queen of Kinwad, who everybody says we should upgrade to the King of Kinwad.

That's so sexist. Why is that an upgrade? The Queen of Kinwad is better. I don't know. People just felt I was being, I don't know how people could say that anointing him as queen would be derogatory. I think these people are not woke and they need to be canceled.

Jason, here you go again, making a lot of assumptions about people's pronouns. Yeah. I'm sorry. They Queen of Kinwad. They of Kinwad. I take no offense to your insults to me. And today I'm having the emotion of excitement and I am ready for the conversation. Good. We got the firmware upgraded.

All right. So I think we might as well start with, I don't know if you guys caught this, but there's a subreddit called WallStreetBets and what they do on WallStreetBets is they find angles and a thesis. And then they bet on a stock. The stock they picked for the past couple of months has been GameStop.

And boy, did they. Jason, hold on a second. Um, that's, that's, that's not true. So, um, do you, uh, I had actually a guy on my team put together two really important documents and I'm just going to read them because it's full of so much interesting shit. And then we can talk about, um, where are these documents from?

You're saying from the WallStreetBets? No, no, no, no. I had a guy go in, uh, one of my team members, one of my colleagues and go and summarize the entire saga from the beginning. And then we can talk about the, the corporatist scumbags at Robin hood and other fucking people over.

So let's, let's do that in that order. Okay. Um, this is why they call him the dictator. Let's uh, let's start with the, uh, no, no, no, shut up. Boring. Uh, document go. You're, you're an idiot. Cause you, you just want to defend people because you blindly stumbled into a fucking trade.

That. Actually made a little money. Lo and behold, you actually invested in a company. That literally they got on television yesterday and they fucking lied to Americans right to their face. This is a company that was insolvent because now let's just put a pin in the following data point, which I believe to be true.

I know more about this than you do because I live in these markets. Okay. So I understand what it means to be putting on trades, to being short, to being gamma squeezed, to have longs, to do all of this risk management. You're an early stage investor. So I know the intricacies of this stuff and what's happening in your, this company was insolvent.

They did not have the capital requirements to post the margin that was being asked of them by their partners. And so this was a platform level decision to ban and block people from trading securities. It costs individuals, hundreds of millions, probably billions, maybe even tens of billions. And these motherfuckers should go to jail.

Now, let me give you the timeline before we get into that. June, 2019. In June of 2019, a wall street bets user named deep fucking value began buying long dated January 21 calls. What that means is in June of 19, this person was betting that the stock would go up by January of 2021.

He spent $50,000, which by the way, today is worth about $25 million. By the way, Shabbat, we should just highlight that there are forums where individuals that are trading stocks. Talk to each other and share tips and promote things to one another. That's where this was taking place. Yeah.

And by the way, those forums exist, uh, in the professional organized world too, amongst hedge funds. You know, I've been invited to idea dinners where we all get together and we talk about the ideas that we have, and we're all expected to do fundamental analysis. Uh, but some of those ideas are actually momentum driven ideas.

And a lot of the biggest dislocations in the market, just as a setup here have been because of momentum driven trading by organizing. Capital. Okay. So we've, we've been stuck with this for a while. So, so this guy deep fucking value posts this and every month since he's posted a screenshot of his position and he's titled it G M E Yolo update.

August 22nd of 2019, Michael Burry, who is this guy famous from, uh, the big short, who's the guy that caught the mortgage thing. He discloses a 3% position in the company, and he highlights that 90%, nine, zero percent of GameStop's 50% of the 5,700 stores are free cashflow positive.

That's like pretty good. He urges a buyback and he notes that the company was trading at or near net cash levels. So he's making a deep value oriented fundamental thesis as well. Shema. I think also it's worth saying what GameStop is. Cause even my wife asked me what the hell is GameStop last night.

GameStop is a retail store where people buy video games. I used to go to the mall all the time and buy video games there and consoles and headphones and other stuff. And they'll buy back your old games. And so the stock got beat up over the last couple of years as people stopped going to malls and stopped buying stuff in stores.

And everyone thought the company was going to die. And so these guys observed that maybe there's real value in this company and it's making money. Digital downloads are the standard. No one buys DVD ROMs anymore or anything like that. So, and, and the chewy founder who is very successful at e-commerce came in to run the company.

Yeah, that's the best part of the story. So June 19 was the original post August 22nd. Of 19, Michael Burry comes in and says, I'm long. Then a year later, August 31st of 2020, Ryan Cohen, who's the founder of chewy takes an almost 10% position in GameStop about two or three weeks later on September 19th of last year, a member of wall street bets writes a post on GameStop.

And he notes that GameStop has 120% short interest, which I'll get to in a second. So hold on. What, what does that mean? 120% short interest. And he defends the company as a result of a few things. He says, number one, there's a new console cycle coming, just as Jason mentioned.

Number two, consoles are, are not going all digital immediately. GameStop loyalty programs have 55 million users. They have a strong balance sheet. Ryan Cohen just bought a steak and the shorts were underwater and would be forced to cover. If the stock ran up, he predicted the convergence of all these factors would lead to a big squeeze.

Now November. 16th of 2020, Ryan Cohen writes a letter to the GameStop board and he urges the company to conduct a strategic review and share a credible plan to capture market share in the gaming industry. He said that they need to evolve into a technology company that delights gamers and delivers exceptional digital experiences.

I'm just quoting here, not remain a video game retailer that over prioritizes its brick and mortar footprint and stumbles around the online ecosystem. November of 2020. Ryan Cohen. 16th of 2020. Someone in wall street bets highlights that a hedge fund called Melvin capital was going long GameStop puts. What does that mean?

That they are synthetically shorting the stock by buying the right to sell it at a different price in the future. Okay. Um, and that they had been long that position for more than four years. So all the way going back to 2016, fast forward to now 2021 of this year.

January of 2021. GameStop strikes an agreement with Ryan Cohen and adds them to the board of directors and gives two of his affiliates, his former COO and CFO of Chewy also two board seats. They collectively, you know, bring their experience in e-commerce, online marketing, finance, and strap planning. The stock goes up 13% on that day and closes at about 20 bucks a share.

One day later. And then over the next day after that. So for January of 2021. January 12th and 13th of 2021. There's a ton of activity around GameStop in wall street bets and now in discord and in stock twits claiming that Ryan Cohen is going to be the savior.

And then by January 14th, so three days later, the stock closes at 40 bucks. So now it's up 125%. So now comes the setup, the pros versus the Joes from January 12th to today. There has basically been a battle by institutional investors on one side, shorting GameStop and retail investors on the other buying the stock and also buying the right to buy the stock or what's called call options.

And this is what has created this crazy nonsense we've seen. So on the institutional side, after, you know, retail drives a stock up, the institutional guys are like, Hey, wait a minute. You know, Ryan Cohen's an idiot. You know, this. This company is fucked. Fuck these guys. They have too many, you know, cyclical and secular tailwinds.

And they become so massively short that the infrastructure that's supposed to even count all the shares can't keep up. And now they are short more than the actual number of shares that actually exists. So now they're 140% short. The Joes retail, they start to aggressively purchase all these cobble options.

And on January 13th and 14th, this price keeps ticking up. Then a bunch of quant funds and momentum hedge funds notice all this activity, and they also participate on the long side. And then over the past seven trading days, we have traded over $100 billion of stock in GameStop, which is well in excess of what retail can support.

So here's what's crazy to realize. A bunch of value oriented, non computerized, non quantitative hedge funds short. Retail notices a dislocation. Initially fundamentally, but then momentum oriented buys. Other hedge funds realize also buy. And this is what's created this massive short squeeze. On January 19th, Citron Research, a research firm that basically tries to, you know, find shorts in the market, announces that they were short GameStop and they gave five reasons why it should go to 20 bucks.

The stock was at 3550 on January 19th. Then over the next two days, GameStop went down. GameStop calls hit an all time high. And it runs a two day rally of almost 70%. And this is what really starts what's called a gamma squeeze. Okay, which is what we saw in the first part of this week.

So January 25th, Ken Griffin, Stevie Cohen, they inject almost $3 billion into Melvin Capital, the firm that was short. 2 billion from Citadel and 750 from Stevie Cohen. Stevie Cohen had a billion in it from before. And then now all of a sudden, the squeeze keeps happening. The squeeze keeps happening.

And then it starts to spill over to the rest of the market. Now all these hedge funds, these original hedge funds, they are getting called by the bank saying, "Hey, wait a minute, you've run over your collateral limits. You need to post more collateral. We need more money in your bank accounts." So now not only do they have to cover GameStop, they have to cover all their other shorts.

So those go crazy. And they have to sell their longs. So now they're selling, you know, Facebook, Netflix, Alibaba. So those things are going down. That accordion is going down. That's what's happening in the market in the last couple of days. And then the coup de grace is what happened on January 28th of 2021.

Brokerage firms, and this is where, Jason, we should talk about this, like Robinhood and Interactive Brokers, because in fairness, it wasn't just Robinhood, prevented their users from buying GameStop and a handful of other stocks. They were only able to sell, which resulted in such a one-way pressure, it caused a 44% sell-off yesterday.

That's been reversed today. And so what it speaks to is a bunch of questions. There are questions as to whether or not this was mandated by the platforms or the regulators. Given the fact that it didn't impact all the brokerage accounts, it was a platform-level decision. So some organizations like Robinhood banned it.

Some organizations did not. And it could be that some of these platforms that banned it is likely because, and this is where we get to the point. I'm going to get to the insolvency question, didn't have enough margin. And so they knew that if they opened the doors, there would be a run on the bank and there would be a run on Robinhood.

And that's why they basically, I believe, had to stop allowing people to trade. And it just shows how fragile the whole system is. The last thing I'll say, and then we can talk about this, is how does Robinhood make money, which I think is also important to understand this.

Robinhood makes money through a mechanism. That's called payment for order flow. So they don't make money from consumers. What they do is they watch and monitor your orders. They create a data file about that and they give it to these prime brokerage institutions like Citadel milliseconds before you do the trade.

What that allows Citadel to do is if they see a lot of people buying, milliseconds before you buy, they can buy. That allows them to make money. To be clear, Citadel is responsible for 47% of all the payment for order flow volume. They paid Robinhood almost $60 million in the third quarter.

Plus another, I think, $7.5 million for S&P 500 stocks and $31 million for non-S&P 500 stocks. They paid them almost $100 million in the quarter or a $400 million run rate. If we had to summarize. If we had to summarize all of this in a nutshell, that's what we know.

We know that it started out as people debating the true fundamental value of GameStop and it morphed into a momentum trade where a bunch of folks got dogmatic about a short, a bunch of folks got dogmatic about being long, and the longs won. In the middle, what happened was a bunch of firms basically decided at some point to gate the game.

They decided to go with the longs. They decided to go with the longs. They decided to go with the longs. They decided to go with the longs. They decided to go with the longs. They decided to go with the longs. They decided to go with the longs. They decided to go with the longs.

E19: Robinhood's GameStop decision: Why did it happen and how can it be prevented in the future?

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