Thursday, 4 February 2021

Short Squeeze

 Every other video on youtube at the moment seems to be explaining the "short squeeze" or "short covering rally" that's happening to GameStop shares.

Imagine it was last April and I didn't have any loo roll. I could have borrowed 4 rolls from one of my well provisioned friends and promised to give him back 5 rolls in May. As it happens It would have been no problem to buy him his 5 rolls in May. Now imagine someone with a better knowledge of paper goods made the same deal and borrowed 4 rolls in April to give back 5 rolls in May. He could have sold them at the height of the panic for, say, £20 and bought the 5 rolls in May for less than £2. He would keep the £18 difference. This is called short selling.

A load of big hedge funds have large short positions on GameStop. The good weirdos of reddit noticed this and all started buying stock and promising to keep hold of it. When it was time for the hedge funds to give back the stock that they'd borrowed there wasn't any for sale and the price skyrocketed.

There are two misinformed comments that I keep seeing:

Firstly – "They were shorting more than 100% of the stock. It shouldn't be allowed". Nonsense! And if you ever find out how few pound coins there are in bank vaults compared with how many pounds people think they have in their accounts you'll lose your mind. Imagine that Ace Plant Hire rent a mini-digger to Bagshot Garden Machinery for 6 months. Bagshot Garden Machinery rent the mini-digger to Charlie for a long weekend. While it's in Charlie's garden both Bagshot Garden Machinery and Ace Plant Hire are owed a mini-digger but there's only one mini-digger to pay them both back with. It's the exact same situation.

Secondly "Short selling is immoral. It shouldn't be allowed". Nonsense! It allows people with good information to force capital to move to more productive enterprises and pays them for their trouble. If a short seller is right, then they destroy the value locked up in some over-valued enterprise and their assets get redeployed to something better. It means we don't have to wait for the buggy-whip factory to slowly go bust before we can tear it down and put up a factory that makes something people actually want (like electric cars or a smug sense of self-satisfaction). We are all (on aggregate) better off as a result.

Richard "to the moon" B

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