Malt Liquidity 27

Capital Riot

MKT ULTRA

Tuesday I wrote about two stories that I thought were fun - Elon tweet ticker pump, and Citadel funding Melvin Capital.

And then, after market closed, Gamestonk.

All hell broke loose. From 1:03 PM PST Tuesday to today, my phone has not stopped pinging. GME rocketed up, along with all sorts of random tickers making incoherent moves. Remember when I said “I love this trade - indirect, offsetting exposure where they win on both sides as long as the rules of nature don’t endlessly continue to not exist”? Well, all it took was a single Elon tweet to pop GameStop to above 300 and for Citadel’s adherence to “regulations” and “legality” to disappear immediately. Thursday morning, Robinhood (and other brokers) decided to suspend any trades other than liquidation on GME, AMC, and whatever other ticker they felt like was moving “too much”. This is particularly notable in Robinhood’s case because a) a majority of users in Robinhood had a position in GME and b) a significant amount of RH's order flow is executed through Citadel securities.

It logically makes no sense to suspend all retail trading in a stock but for liquidation. If everyone can only close trades, who is willing to buy that is capable of getting filled? This would only be put in place if someone needed the price to tank. So here is my theory on what happened in GME:

1. When you are making a market in something that is surging upwards, you can’t ever cleanly hedge the price. After all, hedging does account for the possibility of the price moving the other way. Think about a sports book - if absolutely everyone wants to bet on the big favorite, why would the house open a line if they are taking all the risk against it?

2. Citadel makes markets for both options and equity, and probably for most if not all of Robinhood’s GME flow. I pointed out the other day that a lot of these traders are buying calls, not just shares. So when you fill a call, you are naturally short delta, so you buy some stock to hedge. But if someone also wants to buy the stock, you can fill them, make a spread on their stock purchase price vs your purchase price, and re-hedge. Sounds simple enough - but GME is extremely volatile, thin, and prone to getting halted. So if the price gets halted while you are in the middle of performing this multi-product transaction and the stock reopens heavily against you before you can hedge, you’re all of a sudden short a stock that is surging upwards.

3. There weren’t a lot of options in GME available originally. On the first surge up to 40, the highest available calls were in the 60s. After each surge, new options were opened around 25-30% out of the money, and were instantly acquired (seriously - look at that Jan29 expiry!) It is a reasonable assumption that between 40 and 165, there were a lot of strikes that Citadel was unable to hedge.

4. The Melvin Capital bailout might have just been a press release to try and calm the mania. Even now, I am not sure why exactly Melvin is the punching bag - what’s in a name, after all? But the stock kept going up, aided by Elon’s halo effect, and clearly retail was not buying that Melvin was actually closed out.

5. Option expiry is this Friday, and the fact that these potentially unhedged options were exponentially in the money increases the amount of margin and loss you are taking very quickly. It wasn’t just this expiry - there was plenty of OI in monthlies across the board, with well over 200k contracts in many expiries. (Notably, u/DFV had April calls). Citadel also was rumored to have additionally shorted on top of the Melvin Capital bailout. So they nudge Robinhood into shutting down retail trading other than for liquidation, and brokers oblige because so many people bought on margin that they were running risk themselves on awful execution (lol) on a thin market blowing out their cash reserves. The goal here is to get all these options below intrinsic prices in the retail panic to cash out, exercise them, and bully their short positions into being profitable.

6. However, some institutions definitely caught wind of this. Even when retail was banned from trading GME and the entirety of America was melting down over it, the stock was still catching a bid, which had to come from trades with quality execution. In fact, I’m pretty sure the low ticks of the day were just Robinhood forced liquidations. A notable competitor of Citadel’s, Susquehanna, holds a 6% stake in the company. If you’re already up billions on a position - their average cost was something around $6.50 a share - why not try and screw with your competitor who clearly is over-levered and getting blown out every which way? So someone bids up the stock, and once retail gets their hands on green buttons again, the stock barely dips below 230 noticeably until close, and immediately regains a bid after hours.

7. Frankly, if GME doesn’t close well below 100 tomorrow, I think someone major is screwed - potentially Citadel. Strikes between 40 and 165 look especially painful. It’s a warning sign when even clearinghouses are initially only allowing liquidation trades, as it’s almost like they are assuming someone can’t pay up. Citadel acted blatantly illegally in my eyes - as a market maker, if you pay for order flow, you have a duty to at least attempt “best execution” (though the definition of this varies.) By being the major executor of Robinhood’s flow, encouraging them to shut it off in one direction is essentially equivalent to front-running a bunch of trades you know can only go in one direction while hammering down the price. I’m honestly amazed that GME held up today - this morning, I thought it was done for.

No matter what, option expiry is going to be absolutely nuts tomorrow. Robinhood will probably file for chapter 11 before GameStop ever would have as a dead mall retailer turned Funko pop dispensary, order flow sale as a revenue source is likely dead, Citadel hopefully isn’t allowed to act as a market maker again, and a few random hedge funds blew up. What did we all get out of this? I’m not particularly sure, but god damn if it isn’t the best two trading days I’ve ever seen.