Iceberg Research revealed a short position on AMC on Friday, staking out a claim against one of the buzziest retail stocks to date.
Arnaud Vagner, the main short-seller behind Iceberg, told Insider that AMC’s current stock price, hovering around $50, has been unsustainably inflated by call options activity in the already-tough theater business.
“The volatility of the meme stocks is largely driven by call options, and their ‘gamma squeeze effect,'” Vagner said – referring to a situation where a stock’s sharp price increase forces market makers to buy more shares, accelerating the stock’s ascent.
“However, this effect is temporary and the correction is inevitable. The volume of call options has substantially declined,” he added.
In a series of tweets announcing the short, Iceberg described the AMC “pump” as “increasingly shaky,” calling the weaker fundamentals of AMC “obvious.”
“We don’t accuse the company of fraud. There is a price for everything and we believe the pump has exceeded its average life,” Iceberg tweeted.
In previous years, Vagner’s Iceberg made headlines for knocking some 99% off the share price of Noble Group, a big commodity trader once worth nearly $12 billion, after Iceberg alleged massive accounting fraud.
More recently, the short-seller released a report in April on Diginex, a crypto exchange that went public via SPAC, alleging corporate governance “red flags” and noting the founder had sold 96% of his shares. Since the report, Diginex shares have fallen 23%.
AMC stock has undergone a disorienting run-up in recent months. After spending 2020 in the single digits, it has skyrocketed to as high as $72.62 in early June. AMC was trading at $49.40 as of 12:45 p.m. ET.
DraftKings plunged as much as 12% Tuesday on allegations by a short seller of illegal activity.
A report from Hindenburg Research published Tuesday morning, which unveiled the firm’s short position in the online sports betting company, claimed DraftKings had “systematically skirted the law” via two Bulgarian subsidiaries. Meanwhile, insiders made use of market froth to sell more than $1.4 billion in DraftKings shares, Hindenburg alleged.
In a statement, DraftKings downplayed the findings.
“This report is written by someone who is short on DraftKings stock with an incentive to drive down the share price,” the company told Yahoo Finance. “We conducted a thorough review of [one of the Bulgarian subsidiary’s] business practices and we were comfortable with the findings.”
Released ahead of market open, the report sent DraftKings shares sliding, bottoming out at $44.65 a share versus a previous close of $50.62. But by 11 a.m. New York time, the stock had recovered around two-thirds of the initial drop, and had remained stable as of this writing.
Since the Supreme Court legalized sports betting nationwide in 2018, DraftKings has leaned on partnerships with high-profile brands, like the NFL and NBA, to stand out in a crowded, sometimes opaque market.
The firm went public through a SPAC in 2020, combining with one of the Bulgarian subsidiaries, called SBTech, that Hindenburg accuses of criminal conduct.
The DraftKings drop continues a rough stretch for the stock, which has fallen 28% since mid-March.
Shares of the company were trading 4.65% lower at $48.26 as of 3:29 p.m. ET on Tuesday.
Hedge fund Mudrick Capital lost 10% in just a few days of trading as shares of meme stock AMC Entertainment spiked to record highs, the Wall Street Journal reported, citing people familiar with the matter.
The losses were driven by call options sold by firm founder Jason Mudrick, according to the WSJ. The position, intended to serve as a downside hedge, ended up backfiring as the stock surged too much, too fast.
The runaway share spike occurred on June 2, when AMC shares rose as much as 127%, to $72.62, well beyond the strike price of $40 for Mudrick’s options.
Just one day prior, Mudrick had disclosed a $230.5 million purchase of new AMC stock, then immediately sold those shares at a profit, according to a Bloomberg report. Despite the success of that leg of the overall AMC trade, Mudrick’s calls on the stock were still held short, leaving them vulnerable to the June 2 surge, the WSJ found.
Mudrick did close out all options and debt positions on June 2, albeit too late to avoid the squeeze. While the fund did earn a roughly 5% return on the debt, it ended up absorbing a net loss of 5.4% because of the options trade.
Though the fund took a hit amid the surge, it’s still up about 12% for the year, the Journal said. Meanwhile, AMC, the world’s largest movie theater chain, is up more than 2,000% year-to-date.
Retail traders have been dealing blows to short sellers and hedge funds this year as they’ve poured into stocks with high short interest rates in order to force a short squeeze. Earlier this year, investors on Reddit’s Wall Street Bets led a share price surge in GameStop, which caused short sellers to lose billions.
Amid the renewed meme-stock interest in recent weeks, short sellers have continued to lose money in retail-trader favorites like AMC and GameStop. The meme stock trade has scared off many short sellers from heavily betting against certain stocks.
Melvin Capital, the hedge fund that dug itself into a hole during the GameStop saga, extended its first-quarter losses to 49%, according to a Bloomberg report.
The firm, founded by portfolio manager Gabe Plotkin, saw a 53% decline in January, reversed some of that loss by gaining 22% in February, but slid another 7% in March, Bloomberg said, citing sources.
Melvin was among a handful of short-sellers that got torched by the Wall Street Bets army that bid up GameStop’s shares, leading to massive losses for those that wagered bearish bets against the video-game retailer.
The fund closed its short position against GameStop on January 27. It started out this year with $12.5 billion in assets under management, but ended January with about $8 billion. Steve Cohen’s Point 72 and Ken Griffin’s Citadel injected a $2.75 billion investment in Melvin to support its battle against the Reddit army.
Plotkin racked up about $860 million through 2020 after his firm returned 53%, but January’s deep decline left him with an estimated personal loss of $460 million, Bloomberg reported.
Plotkin was grilled before a congressional panel in February, where he defended his short position and said it was never part of an effort to “artificially depress, or manipulate downward, the price of a stock.”
A spokesperson for Melvin didn’t immediately respond to Insider’s request for comment.
GameStop said Tuesday that its stock is -and continues to be – “extremely volatile.”
Moreover, that volatility is “due to numerous circumstances beyond our control.”
The statement in a regulatory filing is the first such statement from GameStop leadership on its ongoing stock price fiasco that’s seen its shares rise as much as 1600% in a matter of weeks.
Under the “risk factors” section of the annual report, the company’s stock volatility is listed as the primary risk factor related to the company’s stock. It specifically cites “short squeezes” as a primary reason for that volatility.
“The market price of our Class A Common Stock has been extremely volatile and may continue to be volatile due to numerous circumstances beyond our control,” GameStop said in the filing.
GameStop’s stock value has been explosively unpredictable since mid-January.
Between January 15 and January 27, the price leapt from around $35 to just shy of $350. It’s seen similarly huge dropoffs, but months later it’s still in the $180 range.
The reason, of course, is the much discussed “short squeeze” from a large group of individual investors driving up the company’s stock price in an effort to defeat short sellers betting against the stock. It’s been a major topic of discussion for the past several months for loads of people in media and on Wall Street – except for GameStop leadership.
The company has more or less stayed mum for weeks, and even declined to discuss it on its quarterly earnings call this past week. Instead company leadership focused on the company’s ongoing “transformation” led by Chewy cofounder and former CEO Ryan Cohen.
Since Cohen joined the company’s board in January, taking charge of a “strategic” committee soon after, the company made a string of high-profile hires from the likes of Amazon and Chewy.
It is unclear what Cohen’s specific plans are the future of the company, but he broadly outlined plans in an open letter to the company’s board in late 2020.
GameStop, “needs to evolve into a technology company that delights gamers and delivers exceptional digital experiences,” Cohen wrote in the letter, “not remain a video game retailer that overprioritizes its brick-and-mortar footprint and stumbles around the online ecosystem.”
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SPAC IPOs have been all the rage since the COVID-19 pandemic began, and the trend has only accelerated in 2021. Now short-sellers are beginning to take notice.
The group of investors has tripled bearish bets against SPACs to $2.7 billion, from $724 million at the start of the year, according to data from S3 Partners first reported by The Wall Street Journal.
Short-sellers have a lot of SPACs to sift through, given that the $166 billion raised by SPACs in the first quarter of 2021 exceeds all of the SPAC deals formed in 2020. But high-profile short-sellers seem to be having no problem finding their targets.
Muddy Water’s Carson Block released a report earlier this month on XL Fleet, a recent SPAC IPO that, according to Block, misled investors on an inflated revenue backlog for its retrofitted hybrid vehicles. The share price of XL Fleet has yet to recover from Block’s short report.
Short-seller firm Hindenburg Research, which rose to fame last year after it released a damaging short-report on Nikola, has also had success targeting SPAC firms. Hindenburg released a report on Lordstown Motors last week, alleging that the SPAC-merged company has “no revenue and no sellable product.” Shares of Lordstown dipped more than 20% and have yet to recover from the decline.
Even the SPACs led by billionaire investor Chamath Palihapitiya have been unable to avoid the scrutiny of short-sellers. Palihapitiya’s recent Social Capital SPAC merger with fintech firm SoFi has more than 20% of its share float sold short, according to data from Finviz.
Besides the underlying business concerns raised by short-sellers for SPACs, underlying trends in interest rates could be helping their bets against SPAC mergers. A majority of the companies going public via SPAC merger are not profitable, and don’t forecast profitability until years down the road.
The dearth of profits hasn’t jived well with investors as interest rates have risen over the past few months, sparking a rotation out of high-tech growth companies and into cyclical stocks in the energy and financial sectors.
Now, Congress and US regulators are reviewing what happened to see if there are any vulnerabilities in the stock market that need to be addressed. Regulators are considering rule changes on everything from options trading, to short-selling and gamification practices by investing apps like Robinhood.
On Tuesday, Senator Elizabeth Warren shared the responses to her previous letters that asked the SEC and FINRA how they planned to respond to the volatility in GameStop. The responses revealed a list of issues the regulators are now examining.
The SEC said it is evaluating if there are any gaps in its market manipulation rules. The agency also said it will “seriously consider” increasing the requirements for brokers that offer options trading, and increasing disclosure requirements for brokers that deal with payment for order flow and for hedge funds and investors that engage in short-selling.
FINRA, meanwhile, said its looking into the gamification of the stock market by investing apps like Robinhood, and whether its current rules adequately address the risks presented by these practices. Both FINRA and the SEC said they are still investigating if there was any wrongdoing related to the meteoric rise of GameStop earlier this year.
“The GameStop controversy revealed how the Wall Street game is rigged in favor of big hedge funds and giant corporations – and how this hurts individual investors and the economy. I’m going to keep fighting for answers, a level set of rules, and a transparent and open market for everyone,” Warren said.
Gabe Plotkin’s hedge fund Melvin Capital gained a chunky 22% in February, according to reports, but the investment firm remained in a deep hole after being battered during the GameStop saga.
The 22% gain, reported by numerous outlets, well outstripped the 2.6% rise in the S&P 500 across the month.
Yet Melvin Capital lost 53% in January after hemorrhaging money on its bet against video-game store GameStop, which skyrocketed when amateur traders organizing themselves on social media website Reddit got behind the stock.
The $8 billion fund needs to produce gains of 75% before earlier clients break even, Bloomberg reported. That is a tall task, even for a fund that posted average yearly returns of around 30% from 2014 to 2020.
However, hundreds of millions of dollars have flowed into the fund from investors who are confident in Plotkin’s abilities, Bloomberg said. Insider has contacted a media spokesperson for Melvin Capital for comment.
Melvin’s February gains are in part due to tweaks to Plotkin’s trading strategy. In testimony to Congress on the GameStop saga in February, Plotkin said he had “learned” from the episode. “I am taking steps to protect our investors from anything like this happening in the future,” he said.
For example, Plotkin has stopped using exchange-traded puts – contracts that allow investors to make money if a stock falls – which show up on regulatory filings and allowed his bets to be singled out by day-traders, Bloomberg reported.
The fund took an injection of $2.75 billion in cash from hedge funds Citadel and Point72, the latter run by Plotkin’s mentor Steve Cohen, as the day-trading frenzy rocked the firm.
He also said in his Congressional testimony he would avoid situations where lots of investors are betting heavily against a stock.
Crowded shorts are vulnerable to the types of so-called short squeezes that battered Melvin in January. Squeezes happen when short-sellers are forced to buy back the stock to cover their positions, driving the stock price upwards.
In late January 2021, shares of a company called GameStop stock, which had been trading around $2.57 per share, suddenly shot up, eventually as high as $500 – when users of the Reddit website subgroup Wall Street Bets began buying up shares.
This was bad news for a lot of other investors, known as short-sellers, who had bet the stock would keep falling. Unlike most investors, who want their stocks to appreciate, short-sellers make money when stock prices go down and lose money when they go up.
So when GameStop started gaining, these short-sellers were caught in what’s called a short squeeze. They had borrowed to support their pessimistic investment, and they now had to pay it back – by buying GameStop shares at the higher prices. Or else, hang on – and risk losing even more money.
A short squeeze is a stock market phenomenon, something that happens to investors and traders who have acted on the assumption that an asset (a stock, usually) is going to fall – and it rises instead. Here’s how it happens.
What is a short squeeze?
To understand a short squeeze, it helps to understand short selling, aka shorting, a sophisticated investment strategy in which traders or investors sell stocks they don’t actually own, in hopes of buying them back later for less money.
It works like this: A short-seller borrows shares (usually from their broker) they think are due for a fall or to keep on falling, and sells them on the open market at the current price. When the stock’s price drops, as the short-seller was betting it would, they then buy the shares back for the new, lower amount. They return the borrowed shares to their stockbroker, keeping the difference in price as profit. In the interim, they’re charged margin interest on the shorted shares until they pay them back.
The entire strategy hinges on the bearish view that the stock is going to drop in value. But what if it goes up instead? That’s when a short squeeze happens.
When a stock rises sharply and suddenly, short-sellers scramble en masse to buy shares to cover their position (their loan from their broker). Each of these buy transactions drives the stock even higher, “squeezing” the short-seller even more. They have to keep covering their positions or get out totally – at a loss.
How does a short squeeze happen?
Here is how a short squeeze scenario unfolds:
You identify a stock you believe is overvalued, and take a short position: borrowing and selling shares at today’s high price in anticipation the price will go down and you will be able to buy replacement shares at a much lower price.
Instead, something happens causing the price of the stock to start going up. That “something” can be the company issuing a favorable earnings report, some sort of favorable news for its industry – or simply many other investors buying the stock (as happened with GameStop).
You realize you are unable to buy the stock back at a low price. Instead of sinking, it’s climbing – and it exceeds the price you bought it for. At this point, you must either buy replacement shares at a higher price and pay back your broker at a loss, or buy even more shares than you need – in hopes that selling them for profit will help cover your losses.
All this increased buying causes the stock to keep going up, forcing even more short-sellers like yourself into a tighter vise. You have the same choices as above, only the stakes keep mounting, and so do your potential losses.
Protecting yourself against a short squeeze
There are specific actions you can take to try to protect yourself against a short squeeze or to at least alleviate its grip.
Place stop-loss or buy-limit orders on your short positions to curb the damage. For example, if you short a stock at $50 per share, put in a buy-limit order at a certain percentage (5%, 10% or whatever your comfort level is) above that amount. If the shares rise to that price, it’ll automatically trigger a purchase, closing out your position.
Hedge your short position with a long position – that is, buy the stock (or an option to buy the stock) to take advantage of rising prices. Yes, you’re betting against yourself, in a way, but at least you lessen the damages of the losses and benefit from the price appreciation.
Predicting a short squeeze
Short squeezes are notorious for descending quickly and unpredictably. Still, there are signs a short squeeze may be coming:
Substantial amount of buying pressure. If you see a sudden uptick in the overall number of shares bought, this could be a warning sign of a pending short squeeze.
High short interest of 20% or above. “Short interest” is the percentage of the total number of outstanding shares held by short-sellers. A high short interest percentage means a large number of all a stock’s outstanding shares are being sold short. The higher the percentage, the more likely a short squeeze may be building.
High Short Interest ratio (SIR) or days to cover above 10. SIR is a comparison of short interest to average daily trading volume. It represents the theoretical number of days, given average trading volume, short-sellers would need to exit their positions. The higher this number, the more likely a short squeeze is coming. Both short interest and SIR are on stock quote and screener websites such as FinViz.
Relative Strength Index (RSI) below 30. RSI indicates overbought or oversold conditions in the market on a scale of 0 to 100. A stock with a low RSI means it’s oversold – that is, trading at a very low price – and possibly due to increase; a high RSI indicates the stock is extremely overbought – trading at a high price – and possibly due to drop. Any RSI below 30 signals an imminent price rise, which could lead to a short squeeze. A company’s online stock listing usually includes its RSI, often under its Indicators section.
The financial takeaway
A short squeeze can result when a stock – especially one that had been declining in price – suddenly goes up for whatever reason.
This puts short-sellers, who bet the stock would drop or to keep on dropping, in a bind. They sold shares they didn’t actually own, and now, to cover their positions – repay the stock they borrowed -they have to buy increasingly expensive shares. Each of these buy transactions drives the stock even higher, forcing more short-sellers to spend more or get out at a loss. They call it a squeeze but it becomes more like a vicious cycle.
There are indicators to predict a short squeeze, and ways to protect yourself against one. But overall, a short squeeze is one of the facts of life for a short-seller – and a reminder of the risks that sophisticated trading strategies like short selling carry.
The US stock market is witnessing the biggest “short squeeze” in 25 years, forcing hedge funds to withdraw from their positions on stocks at the fastest rate since 2009, according to Goldman Sachs.
Last month saw GameStop shares rise more than 1,700%, “squeezing” hedge funds and others who had “shorted” the stock, costing them billions of dollars. A short position is a bet that a share price will fall.
Goldman Sachs analysts this weekend shed some light on the situation in a note. “The past 25 years have witnessed a number of sharp short squeezes in the US equity market, but none as extreme as has occurred recently,” they said.
The equity analysts said a basket of the most-shorted US stocks has rallied 98% in the last three months. Estimates by data provider Ortex on Friday showed that short-sellers were sitting on losses of around $19 billion just on GameStop in 2021 so far.
Hedge funds and short-sellers who had made losing bets were forced to withdraw from the market rapidly at the fastest pace since 2009, in what is known as “de-grossing”.
They had to buy shares in companies such as GameStop and movie theater chain AMC to close their short positions, and sell other stocks to cover their losses.
“This week represented the largest active hedge fund de-grossing since February 2009,” Goldman analysts including David Kostin and Ben Snider said. “Funds in their coverage sold long positions and covered shorts in every sector.”