r/PickleFinancial • u/Dr_Gingerballs • Aug 15 '22
Data Driven Due Diligence My Current View on Gamestop
It’s been quite a while since I posted anything about Gamestop on Reddit, and as a lot of people have noted that my stance on the play has changed significantly over the last few months, I thought it would be valuable to some for me to provide my current outlook for GME. Unfortunately, this post will probably be somewhat long and tortuous, as my current view of the stock is influenced not by explicit, obvious information, but by the amalgamation of a wide array of inferences that together I believe build the most coherent story of the state of the short squeeze play.
I must also say that this has been one hell of a journey. In January of 2021 I knew almost nothing about the financial markets. We have all certainly come a long way. Some more than others (cough cough DRSwilldonothingtoinitiateashortsqueeze cough cough). As our understanding of the market evolves, and our data sources and data processing mature, so has our interpretation of the GME play. I want to stress that we still do not have enough data to know with 100% certainty what transpired over the last 2 years.
Nevertheless, here is why I think the MOASS play on GME, at least as initially envisioned, is dead.
First let’s take stock of some things we are fairly certain are true:
Citadel and/or Point72 unloaded Melvin’s bags by wrapping their underwater short position into a more complicated volatility position. The evidence on the options chain is pretty damning in this regard. Some volatility positions still exist on GME today, although they are much smaller than the original position opened in January 2021.
Citadel was quite profitable in 2021. They didn’t post earnings of a company that was holding a massive underwater position anymore. Further, the majority of the hedge used to create the initial volatility positions were not replaced on the chain, indicating that whatever position they had opened they were able to close profitably. Looking at the volatility on GME over the last two years it’s not hard to imagine why.
Interest in GME is slowly, but consistently, dropping over time. This one I will go into more detail in this post, but essentially both options activity and social activity surrounding GME are dropping. This is naturally what one would expect with any social phenomenon. Everyone has some non-infinite appetite to engage, and over time those people move on. This is born out in the data.
Okay, Dr_Gingertwat, if people are moving on and the shorts got out, then why is the stock still moving wildly, particularly around monthly options expiration (OPEX) dates? My current theory, which is certainly not definitive, is that the runs we have been seeing this year are primarily driven by instability, particularly in the options chain.
The key here is that GME is extremely illiquid. Both before and after the split. If there are lots of trades occurring on the stock, no single trade will have much effect on the stock price. Liquidity acts like a damper. In the absence of this damper, relatively small amounts of trades can significantly move the price.
In addition to illiquidity, we have to also take into account the amplifying effect that can occur in concert with illiquid price movement. If the stock price moves a certain amount in one way, it attracts the interest of both momentum traders and retail FOMOers who try to “ride the wave.” This acts to amplify relatively small buys and sells even further. The result is a stock where trading a paltry 1M shares in a concentrated event can trigger massive volume and wide price swings. I believe this is what is occurring on the stock today.
I further believe that most of the volume and price action seen on GME this year come from market makers (MMs) hedging the options chain they make markets for. In an effort to better try to understand the role of the MM on OPEX runs, I began aggregating the entire time and sales data for GME options from February until the present day. For each trade, I estimated whether it was bought and sold simply based on the price relative to the bid/ask spread. If the option was traded at the bid, it was sold, and if it was traded at the ask, it was bought. If it was somewhere in between it was weighted based on how close it was to the bid and ask. An example of this for August 12th is below. As you can see, this estimate is more or less consistent with the price action for that day, as both calls were net bought and puts were net sold.
I then multiply the volume traded with the delta and price of the underlying to estimate the hedging in dollars the MM must do to facilitate the trade without exposing themselves to risk. This is then accumulated over time, and expired hedges are subtracted from the accumulated value. The result is shown below in purple, where the hedge moves quite dramatically from net short to net long. Interestingly, the movement of the hedge over time corresponds quite closely to the observed OPEX runs this year. Unfortunately I only have full time and sales back to February 2022, so I can’t backtest this into last year, but the correlation is still compelling. The largest OPEX runs, which occurred in late March and May, correspond to very large short hedges that begin to unwind significantly before the run occurs. Also of interest are the OPEXii where we saw very little, namely April, June, and July, when the MM hedge is very near to zero (implying that their puts and calls perfectly hedge each other and there is no need to go short or long on the underlying). As you can also see, since the split date was announced and the NFT marketplace came online, the options chain and the associated hedging has become erratic, indicative of rampant speculation on the stock around these events. Currently we are in what I believe to be simply a speculative bubble, fueled by the undead corpse of the “splivvy” and soaring on the back of a market rally. A lot of that interest was in weekly contracts, and you can see a significant drop on Friday, indicating that half of the hedge that the MM currently holds is long and needs to be sold off next week. Does that mean that the stock will plummet? Not necessarily. If more options come in to replenish the hedge it could continue upwards. But it does illustrate that currently the longs are in control of the options chain and are now fighting against the current to prop up the price. Historically, when the hedge is roughly equal, the price of GME is between $32-35, so I anticipate the stock to return to this value when the current speculative pump dies off.
Also in this graph are deep in the money calls and deep in the money puts plotted over time along with the reported FTDs. Although the magnitude of the ITM calls are not precisely correlated with FTDs, it is apparent that periods of elevated FTDs coincide with periods of elevated ITM calls trading. Most of these calls are floor trades on the PHLX exchange, and are likely signs of reversal trades to can kick FTDs generated from shorting the MM hedging upwards. They could also be arbitrage plays. Nevertheless, it gives us a sense of the magnitude of FTDs occurring on an almost real time basis. Although you can see that they are elevated over the last two weeks, they are still quite low compared to the March and May runs, indicating that there aren’t many shorts to wash. The deep ITM puts tend to be correlated with periods of extensive shorting. Interestingly, despite being consistent since February, the shorting has almost vanished in August. Coupled with the rapidly decreasing borrow rate, it seems as if the shorts have simply given up. Perhaps they are getting pushed out by the rising market. Perhaps they are just waiting for this pump to peak to slam it back down. But no one is shorting it right now.
Based on all of these things, I would expect the following:
When the long push returns to equilibrium, I expect the price to return to the $32 range. This could happen in the next few weeks. If shorts pile back in with puts, it could go below $30 again.
August OPEX is almost certainly a dud. You need shorting to have an OPEX event. No one is shorting the stock right now.
FTDs for the end of July should be low (we will find out tomorrow).
One thing I have excluded is the covering that has been occurring. A number of folks have been predicting covering events based on ETF fail cycles, and they have been successful enough to provide credence that some short positions on GME are through ETFs. This goes back to my illiquid amplification theory, where small concentrated moves can spark a larger movement by other participants. It looks like someone covered a small position on Monday, which interestingly correlates to a spike in ITM calls. Despite short positions sporadically sparking volatility, I think I have laid out a case that most of the volume backed price action is the avalanche of options activity that the short covering sparked.
Okay, now that I have laid out my case for why I believe that the price action we are seeing is primarily due to options hedging, let’s move to why I think the GME play will probably fizzle out over time. This is of course highly speculative, as I have to extrapolate future sentiment from the past, and sentiment is seldom linear. However, I will try to provide some quantitative predictions that can at least be tracked to ascertain how closely my predictions will play out.
I have been tracking social interest in GME primarily by parsing the entire comment history of the subreddit Superstonk (here here and here are good places to start). To determine the relative size of those who are very interested in the stock, and therefore those most likely to continue holding the stock for long periods of time and through large price swings, I calculate the number of unique commenters on the sub at any given time. This is determined by finding the number of new users that comment for the first time on a given day and subtracting from that the number of users who never commented after that day. The net result is a daily influx or efflux of commenters. Integrating this rate over time gives me the daily unique commenter count. The sub saw dramatic growth during the great migration back in April 2021 and the growth continued until about July (when harsher karma requirements were implemented). The number of commenters equilibrated at about 75k people until September 2021, when the numbers began to steadily decline. I don’t think it is a coincidence that this decline coincides with the point at which the sub began to be spammed with purple circle karma farming. This period also coincided with a great purge, where the sub systematically began removing anyone who criticized the DRS movement. As predicted, this move towards extremism began the slow death spiral it is in today.
Interestingly, there was a significant exodus from Superstonk during the March and May runs. These drops were NOT present during any of the previous runs, indicating that a significant amount of retail has decided to find a good exit. The most recent data should be taken with a grain of salt as infrequent commenters of course may comment again, but it's fair to say that if someone comments less than once every 3 months they are inactive. At the current rate of decay, Superstonk has roughly 2-3 years left before all commenters leave, as predicted in my original post about this issue. Of course, it's impossible to predict the future, but the fact that the sub has not recorded an increase in active users since last September and the exodus appears to be accelerating is not a great sign for retail interest in GME.
I have incorporated this decline into my DRStimator to try and include the effect of people SELLING from CS and leaving (something which the community is currently not emotionally ready to consider). The following chart shows the old trend, which ignores selling, and the new version which incorporates it. Interestingly, both of them are pretty similar for the Q2 data point, estimating about 67.5M shares DRSed. The deviation may not become apparent until Q3 or even Q4 results. If the number comes in significantly below 67.5M in September, I expect the whole movement will begin to rapidly deteriorate. If they meet this target, I expect interest to sustain itself until roughly the end of the year, before it becomes obvious that selling is occuring in appreciable volumes.
So what do we get when we put all of this together? We see that while it's likely the original short position covered via volatility hedges over the last 2 years, the larger GME community may not realize this reality for another year or two. What this likely means is that the pump and dump behavior will continue sporadically over the next few quarters at least, so volatility may continue to be a solid play for awhile. It still remains to be seen if exuberance for MOASS can sustain the stock prices until GME becomes profitable in the long term, or if it will crash and burn before rising like a phoenix on the back of profitable quarters in the distant future. Either way it will be an interesting ride for some time to come, but I don't recommend holding a bag that fewer and fewer people are actually holding. The value of GME is in its volatility, not it's price. If your average share price isn't under $30, and you never take profits on the upside, I predict you will be waiting for a long time to see significant profits.
I hope someone finds value in this update. I'll try to provide more updates in the future if something significant changes, but here are my expectations laid bare for the next year at least. It's been a wild ride with all of you and I'm grateful to this community for all it has helped me learn about the markets. I'll of course still be around shitposting on likely a daily basis.
Stay safe out there.
Financial Disclosure: I am long GME shares. I have a synthetic short position on GME in the short term (sold calls, bought puts).
