Losses From A 1% Short Position In GameStop

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This is a blog post on the news surrounding a short position in GameStop – this article is merely speculation (an educated guess) based on our thoughts and looking at some publicly available data. The below was submitted by a reader who wishes to remain anonymous and is written very informally.

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Q4 2020 hedge fund letters, conferences and more

A 1% Short Position In GameStop

Reckless, incompetent or both.

50% on an $11B fund.  They lost 6 billion dollars.  In a week.

The Math...

A 1% short position = 110,000,000

The total shares outstanding of GameStop, in the fall 2020, was 69,750,000

69.75m x $6/sh = $418,500,000 is the Market Cap.

The total 'float' - or available shares for trading in market is 47m (47 * 6 = 282,000,000 available)

This is a small cap value stock! If they were to take a 1% (short) position, it would require them to locate and sell nearly 1/2 of the total float (110m of 282m) of the shares on GameStop.

Their position, assuming a 1% position, would be 18,330,000 shares (at $6/share - 6*18.3m=110m)

Other hedge funds were selling short too!  And, many players (pensions, mutual funds, etc) dont like to lend their book for short selling - which pushes groups to off balance sheet swaps.  (and that has implications for the counterparties - the brokers - hedging their positions)

*This is why I believe there was a lot of exposure through TR Swap!

Short Against The Rise

So, looking at the stock price of GameStop - they likely were building a position in the summer, and built faster as the price crept up over 10.   It looks to be a 5 or 6 dollar stock.  Then the Pet Food guy started buying, which nudged the price off 6, towards 10 in the fall.

This team began to short it against the rise.  As they were selling, there was definite action going on.  I dont see the blogs, but I imagine there is talk in the fall.  Look at the high volume days and the creep of the stock upward....

Look at the price and volume from Aug 20 to Sept 20... Wonder what the blogs were saying back then?

My guess, this is when Melvin began to short.  I imagine they loved the short at 10, for a 40 to 50% return back to 5 or 6

A 40% return on a 1% position in the portfolio would be 5% - not bad.

But, assuming they short the position at around 10, to fall back to 5....  when the price goes from 10 to 13 and 14 as it did in October.  That rise in price would have cost the short dearly.

Raw performance, the position would be down 40%. (short 10, cover 14).   ANY RISK MANAGEMENT GROUP WOULD QUESTION AT THIS POINT IN TIME.

Pitching The Wrong Investment Thesis

Imagine the discussion in the morning meeting on October 20th when the price hit 14 and the fund was short at 10.  Jacob, the CIO says, whats your thesis on this position?  We have lost 40%.  We should start to cover our losses here, dont you think?

Then you have to tell the CIO why we hold at 14.... OR, we should add to the position and short more!

If I am the CIO, I am thinking that at 15, the position has lost 50% and the investment thesis is WRONG.

If I am the risk manage here, and we are short 18 million shares.....   I am looking at the average trading volume of the stock here.  Its 7 or 8m shares a day.  If I wanted to completely cover the position, at 4 brokers, and be invisible, I'd need to be less than 10% of the volume - aggressively buying to cover - it might take 30 days to accomplish this.

I am thinking that this position comes up every morning on their investment call - Jacob, how are we doing trimming that position?  Are you finding there is volume?

If you say you are having trouble, the Risk Manager suggests hedging some of the position against further rise - options, as you suggest.

Something happened Nov 27, 28, 29. Then Dec 8 and 9 then Dec 22 and 23.

They obviously were not out then.

Things Heat Up After Thanksgiving

It seems the position started to get some velocity after Thanksgiving, and was running against them.  I can imagine they were trying to cover.  By now, the position is trading at 16, a 60% loss on the position.

Fundamentally, this short at 16 makes sense.  i agree.  But you are down 60% and have unfavorable winds - seems they dont know the market and what the winds are telling them.  Perfect time to get out.

When it hit $20/share and we assume they were in at 10, then they are down 100% on the position.   At 20, the position is larger too, 18m share position * 20/share = 360,000,000. so on the 11b fund, this is now a 3% position!  a 3% short!

Recall too, that they have a variation margin, to keep cash against the short.  When they were short at 10, that $10 bucks was kept as margin against the position.  When it went to 11/share, the firm was required to post an additional dollar as margin.  So, at $110,000,000 short thats now 360,000,000 they need in cash margin.

Means they are selling other positions.  Markets are going down, so they are trimming into a falling market.

Market goes to 30 on January 13.   They need 540m in margin.

By Jan 20 thats now $40/share or 720m margin on this one position.

When it goes to 300/share, not knowing their success covering, that margin would have been 5.4B.

I suspect that the GameStop position cost them 10%, then the others (AMC, Blackberry, Bed Bath, Etc) cost the rest.

Either way - these guys are done.  Every dollar will exit.  They may have to gate everyone.