Odd Lots - Benn Eifert Explains How Retail Trading Is Rocking Markets like Never Before

Episode Date: February 3, 2021

We know that retail activity, much of it on Robinhood, has been surging since last spring once the lockdowns began. But just how big of an impact is it really having? Is it going to be limited to just GameStop and a few others, or is this a permanent fixture of the new market landscape? We discuss this with Benn Eifert, CIO of QVR Advisors. Benn is an expert on volatility and derivatives, and he helps us make sense of what was so unique about GameStop, and what the ripple effects of this will be.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, Oddlots on Amazon music. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Allaway. And I'm Joe Wisenthall. Joe, remember when you said GameStop was a value investment? Tracy, you're, you're skewing my words. Not really. I said, and this was in the wake of our recent interview with, uh, Rod, it started off as a value investment, which is true. I would not in any sense characterize

the recent trading from probably like 15 to 480 and now back to 177 after hours last time I checked is a value investing. I will admit that's not value investing. Okay. I think we're both agreed on that point. But you mentioned the episode we did with Rod. We talked a lot about the business case for GameStop. He was looking at a lot of fundamentals in the business that made him bullish on it as a company. That was one part of the whole GameStop saga. The other, of course, was what was going on in technicals with both the short squeeze and the gamma squeeze. And I think we need to devote an entire episode to just talking about those. Yes, exactly. Because the story really has, I've kind of been thinking of it has like three parts. The first part, the first

part is guys like Rod and the Roaring Kitty and some of these others, Michael Burry, like make the value case. Then it kind of gets into this short squeeze, Reddit frenzy, gamma squeeze, call buying and everything with that. And I think that's what we're going to talk about today. I know it is. And then there is like the third part, which is everything that this taught us about market structure and Robin Hood and stuff like that.

And maybe we'll get into a little bit of that today because I think our guest knows that stuff well. really like what we're going to do today is go from part one to part two, which is like, when it entered the Reddit retail flywheel, what the hell happened? What does that say about the market overall? Right. The squeezes are how we got to, you know, an increase of 2,000 percent in the space of less than, I think it was less than two weeks, something crazy like that. All right. So I'm really happy to say that we have the perfect person to talk about this. He's a four-time AllBots guest, which might be a record or might match another record.

It's Ben Eiffert from QVR advisors, and he is all about options and the big gamma squeeze. So, Ben, welcome on again. Hey, guys. I'm so happy to be back. It's always a lot of fun. I'm trying to think where to start, but maybe just to begin, you know, in options land, And how crazy has the past week been for you? It's certainly been wild. I mean, as you guys no doubt have seen, there's been enormous amounts of option volume going through

in some of these popular retail names, GME being an obvious one, you know, on some days nearing the types of typical volumes you'd see like in S&P options or in, you know, Tesla options, which is pretty spectacular for a company that, I mean, what was the market cap of GME six months ago? You know, it's been quite wild. But I think this, again, this was particularly crazy week.

But I think as, you know, we've been emphasizing, this is really the culmination, you know, or the current state of a trend that's really been building for quite some time, right? Really start late, you know, starting in late 2019 with surging volumes across a bunch of different brokerages platforms after the, you know, Robin Hood. initiated and a bunch of other brokers started matching zero commission options trade. So I remember I think the last time we talked to you sometime late last summer, maybe it was like October or something like that. And it was kind of like taking stock of this sort of retail options booms. And there's a number of charts that you have showing the rise of one week call options

and the rise of call options in general and the rise of small orders that indicate that so much of this option activity really is taking place at the retail level. Just flash forward to today, how much crazier overall is the market? You know, we're recording this February 1st, February 1st versus, say, last September, October, whenever the last time we talked to. Yeah, absolutely. So, you know, if you think of what those charts looked like of growth of option contract, notional traded by small traders, growth of option.

growth of option premium traded. You know, they looked totally parabolic at the time. And now it's just like you zoom out and that parabolas just kept going at the same kind of, you know, exponential growth rates. So it's been really impressive. I mean, I think there was lots of noise over the last few weeks. You saw some of that data of just making new record after new record after new record, you know, seeing just incredible numbers, you know, 20 million, 30 million, 40 million calls traded in a week by

by this segment of the market and, you know, tens upon tens of billions of dollars of option premium in, you know, very, very leverage types of types of trades. So this trend has continued, you know, to grow at these kind of rates. You can speculate about where this growth has to taper off, but it hasn't yet. So let's talk about how all that retail options activity can actually lead to buying momentum for a stock like GameStop. So one of the things that that we saw last week when GameStop was rising was, there were some people out there going, oh, this possibly can't be, I can't talk. There were some people out there going, this can't possibly be just retail investors because the stock is moving so much and they don't have a lot of

money. But you've spelled out quite clearly in your research and on previous episodes with us just how smaller amounts of retail options buying can actually translate into larger amounts of money flowing into the underlying stock and a lot more leverage. Could you explain exactly how that works? Sure, absolutely. So there's a couple of related components to this. So the first is just the synthetic leverage that's embedded in options. And then the second, which will come to in a bit, is the convexity or the gamma and

like the dealer hedging dynamics. But so just focusing on the first for a minute, And there's lots of different examples that you can go through. But, you know, backing up a month or two to calmer times, you know, before GME implied volatility was, you know, 800%. You know, a small investor could buy a call option on GME with maybe call it one week to expiration. And it might, for example, you know, GME might have been trading at, you know, around 20 bucks. and they might have been able to buy a call option for a very small fraction of that, you know, maybe a dollar or maybe 50 cents that was somewhat out of the money that was

going to be expiring in a week. That leverage that's embedded, the fact that they might get when they buy that option, say 25 or 30 percent the sensitivity to the underlying stock price, but for only, you know, a couple percent, one percent, less than one percent of the actual cash outlay, that creates a big amount of leverage to those kind of trades. So a retail investor might get 10 to 1, 20 to 1, 50 to 1 leverage effectively by speculating on the direction of the stock using those call options. And that's not just a theoretical concept, right?

Because when that retail investor goes out and buys that call option that has a 30% sensitivity or 30 delta to the underlying stock, he buys it from a market maker. and that market maker sells in that call option and then goes and buys that stock in order to hedge the directionality of the position. So that's real trades that go out and are executed in the underlying stock, you know, in lieu of what the investor's doing. Now, the second component of that, you know, on top of just the huge amount of notional dollar exposure

that a small amount of premium outlay creates, is the fact that when those call options, particularly are bought to the upside. So let's, you know, again, go with that case of, a 25 or 30 Delta call option that only has 25 or 30 percent sensitivity to the underlying stock price, right? Stock goes up a dollar. The option should only go up 25 or 30 cents. As the stock goes up and up, it gets closer and closer to that strike price. And the strike price, the delta, the sensitivity of the option to the underlying stock grows and grows and grows as the stock goes

up. And so that dealer, who had initially bought equity to hedge that position, is now going to buy more and more and more equity to hedge that position as the stock rises, right? And that's this notion of of a gamma squeeze or an acceleration effect where if, you know, retail is buying or anyone is buying very large quantities of, you know, short-dated upside call options, that accelerates the movement of the stock, of a stock to the upside because of this virtuous cycle where dealers are buying stock because the stock is going up. So someone buys, say, a hundred call options. The dealer doesn't go out and buy 100 shares. They buy some fraction of that initially because, of course, they don't assume necessarily that the stock is actually going to hit

the strike and that they'll be on the hook. But basically, as the stock gets closer, as the underlying gets closer to that strike, they're then on the hook, you know, the odds that they're going to essentially have to pay out the bet go up and they have to buy more stock to pay, uh, to, to be hedged. Yep, that's exactly right. Think of it as, you know, once a call, once the stock has gone up so much that the probability that it's going to be in the money by the time you reach expiration is really high. At that point, a dealer will be hedged on a full notional. In other words, to your point, an option contract has a 100 multiplier. So if they own 100 contracts, that's like owning 10, that's like exposure to 10,000 shares. At that point, the dealer would just be short 10,000

shares, I would be long 10,000 shares against the 100 option contracts that they're short. But day one, if the delta is only 25, in other words, the sensitivity of the option to that stock price is 25%. There's an implied probability of 25%, but that stock's going to end up in the money. The dealer would only be long 2,500 shares, and they'd be buying and buying and buying as the stock rallies up to that maximum of $10,000. So one of the reasons I find this story so interesting, and I also think it's different to people, you know, pumping up a stock on message boards in the late 1990s during the tech bubble is because of the role of options.

And specifically the fact that there were people on Wall Street bets who were targeting specific options contracts that they thought could have the biggest impact on the underlying stock. And that's, from my perspective, really sophisticated behavior and probably something that we're more used to seeing from, for instance, a hedge fund than a guy, you know, trading out of his basement or something like that. How surprised were you by that or how much did that play a role in forcing the squeeze? Absolutely. So, you know, this, I think a lot of people perhaps underestimated the sophistication of at least, you know, some. of the folks within are at

Wall Street Betts type of community that are leading this type of charge because of how unfamiliar their language sounded, right, because of the, you know,

the rocket ship emojis and all of this kind of stuff. But if you go in and read some of the original posts about the potential, for example, for a short squeeze in GME, you know,

some of the long form, you know, writing there, these are very sophisticated people, right? They understand the dynamics of, you know,

short interest, and float and how shares have to be covered. They understand the mechanisms of option delta hedging by dealers, and they understand the short-dated options have, you know, by far the highest, you know, gamma and the most convexity. It makes this acceleration effect largest, you know, and other little cues. I mean, just silly stuff. But for example, that original short squeeze post had a little mention of something about,

you know, I love ZMath. And that's, that's something. that only an institutional derivatives trader would say because the, you know, the inside joke in derivatives markets is that they're run by French quants. And that's kind of a little ha, ha, ha, about, you know, coming back to that dig, right? So again, that's not, that's not somebody who, that's somebody who's been in the markets in an institutional role. Oh, I, I missed that whole thing. So I guess what you're, another way of saying this is, if you're a short seller, like, I don't know, Citron research, you may not want to wave the red flag in front of that community, thinking

that they're just going to fold at the first mention that the stock is overvalued. Yeah, absolutely. I mean, I think that, you know, one thing, that one little, little discussion that we had, it must have been six months or eight months ago at this point. And I think it was about Tesla, actually, at the time, you know, was that, you know, there were some folks who were making fun of the, of the Tesla laws, right? of some of the videos that, you know, some of the enthusiastic fan base of Tesla was, you know,

describing what they thought about the stock. And my point was, and they were saying, oh, this is the perfect counterparty. That is not, that is not how a smart, how a trader thinks, right? The perfect counterparty is someone who is weak hands and can be pushed out, squeezed out, is leveraged, can be forced out of their position. The worst counterparty in the world is a big kind of ignorant,

or otherwise, right, but unleveraged counterparty that doesn't, that's not going to be pushed out of their position, and that's really excited about their position, right? So I think that this is actually really important. You wave a red flag in front of those folks, you get them mad at you. You're the weekends, right, when you're short a stock, because a stock, you know, we talk about gamma, a short position in a stock is a short gamma position, right? Because you have a, if you short a billion dollars of a stock and it doubles, now you're short $2 billion with it, and your risk has doubled.

And then if it doubles again from there, you're going to lose twice as much money as the first time that it doubled, right? So you have unlimited loss. You're the weak party at the table. On April 4, 2023, around two in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco.

Hey, who did this to you? What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App. From Bloomberg Podcasts, this is Foundering, the Killing of Bob Lee, beginning April 16. So one thing I've been curious about is when you were watching the flows around GME last week, how much of it was fundamental buying and selling versus the gamma or the short squeeze?

Is there a way of measuring that? it's hard to say exactly what fundamental what is fundamental buying and selling in that in that kind of environment right you can certainly model how much of stock volume do you think is dealer hedges on new option positions and dealer hedges on existing option positions it's certainly material in the double digit percentages but so many different things were happening last week right i mean i think it's worth mentioning first of all of course fall were off the charts. Second, last week,

even though it was the culmination of this, you know, of this parabola in GME, in both in GME and the other, you know, AMC and BUI, you actually saw relatively balanced flows from the retail community in

share transactions in those stocks. So there was probably a lot of new buying from, you know, new enthusiastic, you know, members of the group. But there was also a lot of selling, you know, probably some combination of profit taking and other things, which tells you that a lot of the big explosive price action to the upside, you know, in combination with when you look at the rapid de-leveraging and degrossing in the hedge fund community, a lot of that was

forced short-covering, right? And then cascades of forced short-covering by big institutions. So, you know, I think if you were to look at, you know, combine forced short-covering and degrossing among hedge funds and forced in some sense or mechanical trading of dealers in the underlying stock, you know, some very significant percentage of underlying share volume, you know, was being driven by those technical factors. You know, we're talking about ways that this particular market is different from the late 90s and Tracy mentioned, you know, of course we've been talking about the call options buying. That is very new.

You know, it also seems like a new dynamic or an emerging dynamic that might not go away is just like the way social media encourages like buying in packs. Like suddenly everyone is just focused on GME or everyone's just focused on GME, AMC and Nokia. How new is this? Not just the explosion of options trading overall and not just the leverage that comes with options trading, but in so much. potentially concentrated in a very short period of time in just one name or a small handful of names. Yeah, I mean, certainly the extent to which that is true or seems to be true in this environment, I think, is newer. It's taken it to another level. I mean, there are elements of it, you know, which go back a long ways, right? I mean, you think of how did, what were the coordinating factors

behind retail investing trends, you know, over the last 10 or 20 years? And you could point to, like, you know, Kramer on CNBC or something like that, right? Where like, what were the really cool things and the really cool themes? And Kramer would be up there saying he loved a stock and you'd see, you know, huge retail flows for the time. Retail flows, you know, are obviously much bigger in the over the last couple months. But, you know, so part of that element was always there. But I think, you know, social media has been uniquely powerful in coordinating rapid action across a broad, a large community of people, you know, not just within finance, obviously, and in other areas as well. And I think that's going to be part of the landscape, you know, going forward for sure.

There's all manner of, you know, it raises all manner of questions from a regulatory perspective that I don't think it, I don't think anybody has very clear answers to. And I don't think, you know, the regulators have very clear answers to either. Right. This is a, it really is a new dynamic for the SEC to look at and understand how they think about it in the first place. And I've had conversations with friends in regulatory seats who look at this type of thing closely. And I don't think there's any simple and obvious answers as to where this is going to go in the near term from a regulatory perspective. So, I mean, on that note, I know you just said there aren't any easy answers, but some of the commentary we've seen over the past week has been suggesting that this could pose some sort of threat to the stability of financial markets. So if we see this type of swarming behavior that's capable of knocking out a hedge funder to and maybe causing problems for brokerages at Robin Hood and making us all think about, you know,

settlement issues and collateral and things we haven't thought about since the financial crisis, really, that maybe that's a bad thing. That would probably fall under Joe's definition of a bad take, but certainly that conversation has been out there. How are you thinking about the financial risks or the systemic risks of this new behavior? So it's a very good question. I mean, and I think that's where it becomes, there really are two separate issues, right? One is securities laws and regulation around trying to protect retail investors and so forth, right?

And then the other, and around manipulation and the other set of issues around financial stability. And, you know, I think that ultimately when you look at, for example, what happened in a lot of the retail brokerages, especially the smaller, you know, less well-capitalized private brokerages like Robin Hood this week. You know, you saw the whole modern regulatory apparatus and apparatus of collateral and credit management, you know, come into play, right, where there was this huge surge in dollar volume traded, net dollar volume traded by clients of brokerages like Robin Hood in these particular stocks that were moving in a very volatile fashion. And so the systems that we put in place as part of Dodd-Frank, right, where there are

central clearing houses that unsettled trade risk lives at and the charge a credit haircut on, you know, on that dollar risk that turned into these huge margin calls, you know, to Robin Hood that they had to meet. It was a scramble because this all unfolded so quickly. But ultimately, you know, Robin Hood went out and raised $3 billion of new capital plus, right? in a couple of days. And most other, you know, most of the other brokerages have also been able to reopen trading in these names. And like the purpose of that system, right, is to put guardrails around, uh, around the collateralization of brokerages so that you don't have unexpected failures and to have an insurance pool that's large enough across the brokerage system. Right. And,

you know, this was a good stress test, right? What, um, you know, the question is how much crazier, you know, could it, could it be and could it happen too quickly, right? But, I think those are the kind of issues regulators are going to be thinking about. I don't think that regulators, in of itself, I don't think that they would have great concerns about some particular microcap stocks having some crazy activity. The question is, you know, what if this kind of activity became much, you know, much broader? What if it was affecting, you know, creating huge swings in currencies or commodities or, you know, other things that have major knock on effects on economic policy? I think those are the kinds of things.

things the regulators are going to be thinking about. I made a joke a little while ago about, you know, about Wall Street bets going after, you know, the dollar via, you know, via some of the ETFs that are around there. I mean, if Wall Street Betts was actually able to move the value of the dollar by 30% by trading a bunch of out-of-the-money call options, that would probably get, you know, a track to crack down in a hurry. But these are much bigger, those are much larger, much deeper, much more liquid markets, right? And I think part of what the Reddit community knows, and understands, again, coming back to the sophistication of the ringleaders of this kind of operation, right? They understand that they can have a hugely outsized effect in thinly traded,

you know, small caps and microcaps, right? And they can potentially have some impact over a longer period of time in larger asset classes, but nothing nearly as dramatic because ultimately, you know, global financial markets and currencies are measured in the trillions, not in the, you know, tens of billions. So presumably, I mean, this current episode will fade into some of these popular Yolo squeeze names aren't going to be in the news as much. But I'm still like really interested in what the sort of long term effects on just market pricing is. And I'm curious to start like shorting. So there's been a lot of questions now like what is the future of short selling?

Like the whole thing of someone coming out advertising is short, that might be totally dead for a while unless they're ready to out, you know, like total fraud. And honestly, I'm not even sure that would do it because that might just be still acute for the YOLO buyers. Could you see, you know, in terms of taking a directional negative bet, could there be more with options and puts and sort of like, what do you see is the effect if shorting itself becomes perceived as just too risky to do right now? Yeah, I think that's exactly the right question. So, you know, one of the things that we saw last week, right, in very big size, even in names which there's no reason to think were directly targeted by, you know, Wall Street bets, right, was very aggressive short covering across names that were small cap or micro cap that had a reasonable amount of short interest out there, right? Because hedge funds and hedge fund risk managers were very proactively assessing the state of the state of play in their portfolios and where was this risk and where was this risk. and where could there be, you know, this risk manifesting itself, right, and proactively covering that risk. I think that you're going to see much more hesitation to have certainly any kind of meaningful risk position in an outright short within, you know, low liquidity stocks, right?

I think you had a, you know, something that's a bit of an unusual circumstance here, right, which is many of these hedge funds that you read about having lost a lot of money were very large and had. meaningful short positions in pretty small companies. Right. GME at the time when these positions would have been initiated was, you know, a billion dollar company or less. And the liquidity and the float and the volume, it makes it very hard to support, you know, like a $300 million short position and an aggregate short position across the market of, you know, billions of dollars.

So I think you're going to see much more reluctance to engage in that type of activity, right? you're also going to see, I think, much more, much more demand for optionality on those kind of names. So if you really believe that there's a company that's a great short and you have a catalyst and you think that makes sense to be in this bet, you're going to look to structure those trades with puts or put spreads or some type of limited loss, you know, positions that give you, you know, give you staying power, that make you strong hands and not weak hands, right? as a result, you're going to see, you know, significant differences in option pricing in that whole segment of the market, right? The upside, you know, upside options are just going to be bid because that's

your hedge against a short position. The wings in option speak, sort of the deep out of the money calls and puts, you know, are going to be much more symmetrically bid, I would think, whereas, you know, you typically think of skew in most equity industry, most stocks as being, you know, it's more expensive to buy those downside puts than it is to buy those upside calls because there's this, you know, you want to buy insurance and insurance is expensive. You need insurance on the upside against your, against your shorts, right? So I think that that's going to be a long-lasting impact. So the implication here is that the types of options that have been deployed by a lot of people on Wall Street bets with great effect in the case of GameStop, those are going to get more expensive

and possibly harder to use. I think that's probably right. I mean, we've seen really over the last seven or eight years, especially, before the Wall Street bets phenomenon, you know, on the retail side and then also on the institutional side, you know, being common wisdom that, you know, buying options is for suckers, right? Because you pay this insurance premium. You pay this risk premium, right? You're supposed to sell options in order to make money if you think that the stock, you know,

is overvalued. Maybe you don't short it. Maybe you just sell calls on it, right? And you've seen, you have call overwriting and put underwriting and iron condor selling and this kind of common wisdom that you're just supposed to sell options. And I think that really led to, especially after 2017, which saw, I think, a huge surge in that phenomenon, you know, options just being far too cheap and underpriced. I think this is going to generate, you know, the 2020 and 2021 so far have generated very

strong pushback against that and a very strong repricing of options to become much more expensive. But, you know, because of the value of, for example, being able to put on a short position. And as we were talking about earlier today, you know, if you'd bought puts on GME a couple weeks ago, you'd be up a lot as opposed to having gotten blown out of the water on your shorts, right? That's a bit of an odd phenomenon of just how incredibly volatile the stock has gone. But forgetting about that for a second, worst. scenario, you would have just lost the premium, right? And that's incredibly valuable in a world where the alternative is that maybe you're actually down 10x on your position, maybe you're down 50x on your

position. Cutting off that tail is incredibly important. A lot of short daily news podcast focus on just one story. But right now, you probably need more. On Up First from NPR, we bring you three of the world's top headlines every day in under 15 minutes because no one's story can capture all that's happening in this big, crazy world of ours on any given morning. Listen now to the Up First podcast from NPR. What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps.

Listen to leading by example, executives making an impact on the IHeart radio app, Apple Podcast, or wherever you get your podcasts. You know, speaking of short selling, you know, one of the things that the Wall Street bets crowd has really been focused on is like, when are the shorts going to cover? And so they're sort of these crude metrics of how many shorts there are outstanding. How useful are those measures of aggregate shorts? And especially when you think of how short can be combined with options trades such that the holder of the short is not necessarily directly negative. Like, how useful are those measures and how can you, how well do we really know short interest out there in any name? You know, it's certainly indicative, but it's complicated. And there's a lot of different factors going on, right?

And you alluded to some of these. So one way that you can see a bunch of short interest is because, you know, somebody's borrowing a bunch of. of shares and shorting them. And that certainly has been the case in these names. Another reason you can see short interest is if, for example, clients are selling calls, the customers are selling calls to a dealer. Dealers are buying those calls, and then they're hedging them with short stock, right? That's a very different phenomenon. Of course, the customers do, in that case, have a similar risk dynamic. Those shares that are short could be hedges of all kinds of different derivatives positions, they could be hedges of, you know, futures positions in certain kinds of

products. Also, you know, the understanding, you know, the dynamics of rehypification and in shorts where you have, you know, a daisy chain of shorts where, you know, someone borrows a share, it's lent out, and then it goes into somebody else's account, someone borrows that share. And so just looking at aggregate short interest and that's all you know, it doesn't tell you a precise picture, right? And it also doesn't tell you who are the shorts in the sense that, you know, one thing that we hear about last week, for example, is that there was a very large amount of covering from those initial shorts, the original shorts, who were in the newspaper and who lost a whole bunch of money on this. They were replaced in many cases. A lot of those shorts were replaced by folks initiating new shorts, folks who hadn't been short before, right? And so, you know, those are still shorts and maybe you can squeeze them.

But now you're talking about squeezing somebody who put on their short at 300 bucks, as opposed to somebody who put on their short at, you know, 30 bucks, right? And they're in a much stronger position because they haven't lost any money yet. And, you know, they might have a pretty deep wallet. And maybe if you blow those guys out, then some other guys who haven't touched it are going to come in and short at 600 bucks, right? You know, the overall picture, you know, you can have a plan, which is I'm going to buy a whole lot of this stuff.

I'm going to roll these calls up until the shorts are forced to cover and I'm going to sell to them. but you don't really know exactly when that's happening. And actually, that short mix may just be rotating as you push the stock higher. So when we're talking about possible changes to the way the market works as a result of this, there's also the whole sort of retail brokerage dynamic, which you've touched on a couple of times. But one of the big points of drama in the entire GameStop phenomenon was when Robin Hood restricted trading on GME and a few of the other meme stocks. Can you walk us through that decision

and whether or not this might end up being a more common occurrence if we continue to get these social media fuel swarms over stocks? You know, I think we first heard on Wednesday night, Thursday morning, about Robin Hood having maxed out its lines of credit, you know, across several different banks. A bunch of us were discussing kind of the plumbing issues here. on Thursday. So just to walk through step by step here, right, the way a brokerage works is when a brokerage's customers buy and sell stocks, those trades don't settle until two business days later.

When the buyers and sellers are matched up and the cash is exchanged for securities, if a brokerage's customers are buying and selling an equal amount of shares on a given day, then that's really just internal accounting transfers within the brokerage, right? Hey, I've got, you know, these guys bought 50 million shares, these guys sold 50 million shares, we just kind of reshuffle around everything among the accounts. But if that brokerage's customers are big net buyers of a stock, then that brokerage has a big net unsettled position in buys on that stock facing the clearinghouse, right? And those trades don't settle for two days, and that's counterparty credit risk, right? And so what the clearinghouse does, under the modern Dodd-Frank regulations, there's a specific,

sets of formulas that generate how much collateral does Robin Hood the brokerage need to post to the clearinghouse as a function of the risk of those outstanding unsettled trades that they have. And that's going to be a function of how large those trades are and a function of what's the risk on that particular security. And what we heard this week, right, was DTCC raised its haircuts on, the clearinghouse raised its haircuts on these popular meme stocks that we're trading, you know, doubling or cutting half every day to 100%, which is a very reasonable, you know, a thing to do given the risk of those securities. And so what happened was Robin Hood got a margin call for $3.30 billion

at 3.30 in the morning on Thursday morning, right? I'm sorry, on Wednesday morning. I said Thursday morning. And that's, again, that's the way that the system is set up in order to be resilient to credit risk and shocks in the in the in the system right where brokerages have to be adequately capitalized to support the volume of trading that they're doing and you know Robinhood did go out and then and raise a whole bunch of money I mean well certainly one thing that's going to happen now is all of the brokerages are going to be rewriting all of their stress tests for you know increases in volume and increases in risk right you can argue it would have been hard to see to foresee a spike in volume and risk this big this fast you know how

happening. You can go back and forth about how extreme your stress test should be, but you better believe that across the street, everyone's going to be, you know, dramatically increasing those kind of thresholds, right? And as a result, you're going to be seeing capital planning going through. You're going to be seeing, you know, fundraise and get done and more lines of credit put in place. So I think that, you know, that's certainly, well, you know, how capitalized does, you know, the banking system and the brokerage system have to be to support this type of, you know, this type of activity. I think, well, we're finding out. It kind of seems like, I mean, I know a bunch of politicians, Elizabeth Warren and others have, like, criticized it, but it kind of seems like the system worked. Yeah, I mean, I would, I would agree with

that. I think that people, you know, you have to make some choices ex ante, certainly as a business in, you know, in forecasting, okay, how much capital do I need and what kinds of access to capital in the short term? Do I need to manage the expected fluctuations in the nature of my business? You know, this was a very, very large increase in capital requirements over a very very short period of time. And, you know, Robin Hood, I think, did a total disaster on the PR side. But being able, by being able to get out there and raise $3 billion in a couple of days and, you know, get this stuff, you know, back open again, I think is pretty reasonable. Ultimately, it's hard to say that what the system is designed to avoid, right, is cascading failures of brokerages and, you know, people losing tons and tons of money and systemic implications. You know, I don't think the primary, objective of the regulations governing the way our brokerages work and post-collateral is, you know, is the hot stock of the day always available to trade on demand, you know, at any, at any level for any customer? So we touched on this in a previous episode a little bit, but

if we're saying that ultimately the requirements around clearing and collateral and posting collateral in order to protect Robin Hood customers is a good thing, how how would Robin Hood actually go about changing that narrative? Because it seems really, really tough at this point. I think that's the tough thing, right? When you look at the narrative on Thursday, Vlad was very tight-lipped and, you know, went on television and said, didn't really say very much. And I think that's understandable in a sense, right? Because the concern there is if we go out there and we tell the world on Thursday that we just got a $3 billion margin call, and we haven't really figured that out yet, we don't have the money. The concern, right, is that that causes a run on the brokerage. Everybody freaks out.

Everybody pulls all their money. Banks are worried that everybody's going to pull all their money and they pull their lines of credit and there's some kind of cascading failure. Right. So you can see, and that's probably the advice that, you know, he was getting. and you can understand that. But I think that when you look at how fast the narrative got away from them and you look at the anger in the general public that isn't necessarily that hyper-focused in their dinner conversation around, you know, clearing collateral requirements, right?

It created a big backlash and a big brand damage for them. And I don't know, you know, it's not obvious that they're going to be able to get that, you know, to shift that narrative back among really their core client base, this notion of democratizing, you know, democratizing. you know, democratizing trading and democratizing brokerage. So I think that's going to be a big challenge for them. Well, we'll have to have you back when retail options trading triples again from here in three months. Exactly.

To see what to see what even weirder stuff happened in the market. Exactly. We're going to be doing call options on the euro trying to tank the dollar and it's going to be working. And we're going to be like. Don't tell Wall Street bets about the Hong Kong dollar pegs, stuff like that. Yeah, I'm sure I'm sure Kyle is really hyper-focused on that. Sorry, sorry Tracy. I probably shouldn't have even said that into existence. Yeah, why are you doing this to me?

Okay, well, Ben, it's lovely. That was great, Ben. Yeah, it's lovely having you on for a fourth time, and we'll get you that all-bots tote bag in the mail soon. Awesome. I definitely need one, guys. It's always, it's always fun. Sorry if I was a little distracted sitting here in the park. Not at all. So, Joe, I think that was a really important conversation to have.

I know we've spoken about the amazing story, which is some people who made a bullish thesis on GameStop and then ended up making a lot of money. But I don't think you can talk about that story without discussing the technical factors like the short squeeze and the gamma squeeze that went into it. Totally right. I mean, I'll say this, that the short squeeze element was at least part of the thesis. from the early types, at least late last year. I talked about with Rod, but the gammasquoise, the swarm, the effect that options buying had the sort of flywheel effect where more and more buying led to this upward vortex in price,

that is its own distinct thing. And no one talks about the mechanics better than, no one talks about it better than Ben, period. Absolutely. But this is also, I think I said this, but this is why it's so interesting to have seen people like deep effing value, as we keep referring to him, people like deep effing value who were making the crowded short position part of their fundamental case.

And then going after the gamma squeeze through options contracts, that mingling of the sort of fundamentals with the technicals, I find really, really interesting. And it's one reason why when you see the GameStop strategy rolled out to, other companies or to other markets, people are looking for places or for companies with sizable short positions where they could maybe affect a squeeze of some sort. Yeah. And I am like really fascinated by this angle because you've talked about it. Message boards, they've probably been around for like a quarter century, if not longer, if people talk about stocks. But like, so I've been every day after the market ends, like DFV posts

his daily GME YOLO update, like how many millions he's lost. If you look at the comments, they're all, if he's still in, I'm still in. If he's still in, they all, it's all that. So not only do you have this, you have this sort of like cult of the trade itself where everything gets amplified further. So you have the short squeeze. You have the gamma squeeze because everyone's using options. And then you just have this culture of everyone around the world all talking about this one trade. And so you just really see how hundreds of thousands of individual traders, can just incredibly amplify their buying power in a way that I just don't think we saw in the late 90s or prior periods of market enthusiasm. Yeah, and wait till deep effing value gets on a copy trading platform like E Toro.

Like, imagine that if people were able to like follow his trades with just the click of a button. I think that would be pretty interesting. Should we leave it there? Yeah, let's leave it there. All right. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. Follow our guest on Twitter. Ben Eifert. He's so good. He talks about this stuff all day. He learned so much. He's at Ben P. Ifert. Follow our producer, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today.

and check out all of our podcasts at Bloomberg under the handle at Podcasts. Thanks for listening. Hi, I'm PJ Vote. My podcast search engine has a new two-part series for you. Of all the new technologies coming out of AI, the most transformative one might be driverless cars. They're already on the road in 10 American cities, and they're quickly coming to more. We tell the story of how we got here. The secret team at Google that spent 15 years building what might be the safest vehicle on the road,

and we cover the fights brewing in blue cities, where unions and politicians are working to keep those cars off the streets. Listen to search engine wherever you get your podcasts. What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps.

Listen to Leading by Example, executives making an information. on the IHeart Radio app, Apple Podcast, or wherever you get your podcasts.