No. of Recommendations: 8
<>Not that I looked closely at that car wreck, but I thought hedge funds were 'short' i.e. anticipating a share price fall, in the classic manner that has nothing much to do with options. Hedge funds were short Gamestop by borrowing shares for a fee, iimmediately sold the shares in the hopes of buying the shares back later at a lower price in order to return the shares and pocket the difference from this "sell high, buy low (and return the shares)" strategy.
This was certainly a factor--the reason the retail crowd "attacked" the stock.
But it doesn't seem to be the reason the stock price went parabolic. According to the best analysis I've seen, anyway.
The "smoking gun" explanation for the explosion looks to be this (allegedly):
The exuberant punters bought a bunch of very short dated out-of-the money calls. They had low delta (they move little with each $1 rise in the stock price) because they were at strikes considerably above the stock price.
These calls were sold to them by market makers, who ended up synthetically short the stock. Only a little bit long because of the low delta, but they don't like to be net long.
So, at the same time, the market makers hedged their position by buying some stock. Not too much was needed--low delta again.
At the margin, the stock might have ticked up a hair from their buying, but probably nothing to write home about. At first.
This went on for a while...a LOT of options were bought. Tens of thousands of contracts.
The stock price started rising a bit more from all the buying from the hedging by the market makers.
The gap between stock price and strike price was closing, so the delta was rising to 1. (For each $1 rise in the stock price, the rise in the option price rose fast from almost nothing towards $1).
So the market makers had to buy more stock to keep market neutral, even for the same fixed increment in the stock price.
Which of course drove the stock price up again, but more strongly this time because the underlying-to-strike gap was smaller.
This turned into a positive feedback loop at every step--more price move, more delta, more stock bought, more options bought--so the stock price exploded in a very short time.
The short sellers were the ones burnt, but it doesn't seem to have been their short covering that did it. That wouldn't have been enough buying to cause the spikes seen. The key seems to be the time frame.
Jim
