It was a routine submission of regulations, making the kind of hedge funds every three months, where Melvin Capital first showed its hand.
The “Form 13F” filing, which landed on August 14 last year, listed 91 positions it held at the end of the second quarter, including shareholding in household names from Microsoft and Amazon to Crocs and Domino’s Pizza. Halfway up the list: a seemingly harmless bet against GameStop, a struggling video game retailer.
That the New York hedge fund would think that the shares of GameStop would go down is hardly remarkable – many others bet in the same way. Wall Street analysts have had sales ratings on the stock and the trader’s outlook looks grim as players switch to downloads. But using the option market for the bet, which forced him to announce the position, Melvin set a target for himself.
A red-eyed reddit user named Stonksflyingup was not the only one to notice Melvin’s position, but they were perhaps the most tentative. In a video posted on the WallStreetBets message board on October 27 – titled “GME Squeeze and the Demise of Melvin Capital”, with GameStop’s three-letter stock market designation – the Redditor uses a scene from the TV show Chernobyl to portray Melvin as a nuclear reactor that would blow up if the bet against GameStop went wrong.
Within six months, half of Melvin’s $ 13 billion fund had been wiped out.
The David-and-Goliath narrative of the events, in which retail investors organized on Reddit overwhelmed the short-sellers who bet against GameStop, captured the imagination far beyond Wall Street. For many in the hedge fund industry, however, the story has raised the more prosaic question of why Melvin exposed himself so much and why it did not turn out to be a trade earlier – questions he eventually has to answer to his clients.
“I do not understand why Melvin was there, I just do not understand,” said a prominent short seller who looked at GameStop but decided not to bet against the company.
GameStop has long been a favorite target of short sellers. According to IHS Markit, the stake borrowed to support the short positions was between 50 and 100 percent of the total stake in the company. The shares traded between $ 3 and $ 6.
“We get really uncomfortable when one of our shorts has a short percentage ratio of 10 percent,” the short seller said. The higher the short-term interest rate, the greater the risk, because if everyone leaves their positions immediately, a sudden increase in the demand to buy back shares will push up the price further – a classic short-term push. “This is the part where the retailers have it right, to their credit.”
Melvin declined to comment.
That Melvin is so caught up is particularly surprising given the reputation of Gabe Plotkin, who founded the fund in 2014 after working for Steve Cohen at SAC Capital Management years ago. Cohen considers himself one of the best traders he has ever worked with, and poured money into Melvin early on. Plotkin could be picky about the cash from investors he took and would lock up money longer than most other equity hedge funds.
At SAC and Melvin, Plotkin was known as a low but aggressive trader. He did not just focus on short selling, and often placed larger bets on rising stock prices. Nevertheless, he had the reputation of having a short position. Melvin last month managed two of the five largest short positions in Europe, for example, measured by short interest in a company’s share, according to data group Breakout Point.
Melvin’s documentation in August showed that it owns put options for 3.4 million GameStop shares, instruments that increase in value as the stock declines. Buying sales is usually seen as a lower risk than traditional shorting. Puts give you the right to sell shares at a favorable price, but do not commit to it and limit losses at the expense of the option, while losses due to short-circuiting can be unlimited. But a 13F provides only partial details from which it is not possible to calculate the total short exposure of a fund, and Wall Street still speculates on the full extent of Melvin’s position. That was enough to make his hand tilt.
The following quarterly submission reveals something different: Plotkin doubles. According to the 13F published on November 16, Melvin’s option position grew to 5.4 million shares during the third quarter, even though the share price rose 135 percent to $ 10.20.
GameStop shares unleashed the reality of its business prospects © AP
The messages about Melvin on Reddit became more and more so when traders on the forum declared war on the hedge fund by promising to drive the shares “to the moon”. GME alongside emoji with a rocket became a regular sight on WallStreetBets and users named GameStop as ‘the biggest shortest burn of the century’.
The growing risks of short positions have also not gone unnoticed by professional traders.
Fund managers who specialize in investing in undervalued stocks often look to the companies with the biggest shortfall to identify potential candidates, because if they are right and the stock eventually rises, short sellers can help rush the exits to raise the price. . further and faster.
53%
Melvin Capital’s losses in January
Senvest, another hedge fund in New York, noticed the short-term interest rate when it bought GameStop in September, for example, according to an interview the founders gave to The Wall Street Journal, which showed their $ 700 million profit on the stock. has.
An important aspect of short selling involves closely monitoring the trading volume in targeted stocks, says Brad Lamensdorf, a long-term hedge fund trader who manages Active Alts.
‘All investors need to create a kind of process to monitor the market. The volume goes before the price action, ”he said, and the trading history of GameStop shows signs of heavy buybacks in November and December.
“When you see the kind of heavy sponsorship and stock build-up, it’s a dangerous signal for short sellers,” Lamensdorf said.
As Reddit day traders and others piled up, long-time sellers like Melvin had to decide which way to jump. Those who left their positions before the end of the year, while the stock rose in the direction of $ 20, suffered heavy losses – but not as heavy as those who waited until mid-January, when the founder of Chewy. com at GameStop’s board promised to bring it into the digital age, after which the share price became parabolic.
The temptation to keep the course was obvious as GameStop shares were detached from the reality of its business prospects and would one day tumble. But with the level of short-term interest rates rising, not decreasing, the risks increase. Meanwhile, investors have tried to squeeze short sellers from other popular positions, such as the cinema chain AMC, the technology group BlackBerry and more. Many of Melvin’s shorts suffered losses in the disappointment.
“The stocks in question are little guys from a market capitalization,” said Brian Barish, president of Cambiar Investors. ‘What the Reddit crowd managed to do was that this ecology was ripe for dismay by a sudden increase in trade. Even if GameStop has a very bad long-term viability, it’s just too damn dangerous to give it too short to express this opinion. ‘
When Plotkin was forced to end its stakes against GameStop last week and crystallize its losses, the stock hit a high of $ 483 on the day, up 11,000 percent from the second quarter of last year. Melvin took a $ 2.75 billion emergency cash injection from two other hedge funds – $ 750 million from Cohen’s Point72 Asset Management and $ 2 billion from Ken Griffin’s Citadel – to cover the losses and replenish the fund. In just one month, it lost 53 percent of the $ 13 billion it managed at the beginning of January.
Melvin now faces the task of picking himself up from the debacle, with the eyes of the industry on it, but with at least two powerful endorsements. “I have known Gabe Plotkin since 2006 and he is an extraordinary investor and leader,” Cohen said last week as he doubled his protégé. Griffin was also openly in his praise. “We have great confidence in Gabe and his team.”