Malt Liquidity 52
Quarter 1 Report Card
The Green Dilemma
Oil politics and climate politics tend to mirror themselves in interesting ways. At the core of both scenarios is a lack of ability to enforce compliance, whether coordinating crude oil production or carbon output. So it’s interesting to see the price tag being demanded for less-developed countries to shelve fossil fuels - it isn’t small.
At a July global climate gathering in London, South African environment minister Barbara Creecy presented the world’s wealthiest countries with a bill: more than $750 billion annually to pay for poorer nations to shift away from fossil fuels and protect themselves from global warming…
Developed nations say it is unrealistic to put them on the hook for such a large sum without also getting middle-income countries—China in particular—to provide funds. In Paris in 2015, the U.S., Europe and a few other wealthy nations committed to funding poorer countries to the tune of $100 billion a year from 2020 through 2025. They have so far fallen short.
Shifting away from fossil fuels is a prisoner’s dilemma by nature. A simple look at the gas pump can show you how handicapping production, let alone consumption, of fossil fuels can drastically affect inflation and cost of living. To enact stringent climate policies on good faith that other countries will follow is nothing more than handicapping your own economy. Handing the enforcement of compliance to a group of nations is tantamount to sticking your head in the guillotine and closing your eyes.
So naturally, the logical next step is for developed countries to pay underdeveloped countries to not use fossil fuels. After all, how fair is it for countries like the US to go through the Industrial revolution and its consequences and then demand that other countries don’t use fossil fuels to modernize? This scenario seems politically unfeasible, and again, compliance would be an issue. Thus the board is set - if nobody does anything, we all lose. If somehow every country decides to use less fossil fuels, the climate goals are reached. However, if developed countries decide not to use fossil fuels, developing countries can leapfrog ahead and potentially usurp world power status. It’s a damned situation.
The inability to cooperate between cartel members is nothing new if you have ever followed OPEC. Countries might agree to curb production to increase the price per barrel, but surely enough, a country might sneakily increase their production because the increased profit is too tantalizing. And of course, at the next EIA report, this behavior shows itself and the price of oil tumbles. If you’re going to bet on an outcome, I don’t think the odds for cooperation are worth it.
While I’m sure this will be endlessly reported on in the next few days, I figured I’d go through the government’s documentation and fill out my report card on some theories I’ve had, and make some quick notes:
Retail broker-dealers have attracted customers by reducing commissions and more tools, features, functionality, and convenience to transact. Some use promotional or award programs to attract and retain customers, like offering a free share of stock upon account opening, offering tiered credits for certain levels of deposits or for transferring an account…
A number of features, which broadly include behavioral prompts, differential marketing, game-like features, and other design elements or features, appear designed to engage individual investors. These features, which have the potential to leverage large amounts of user data, raise questions about their effect on investor behavior that the Commission explored in a recent request for public comment
I have written about Robinhood and the unhealthy behaviors it promotes prior, and it seems that the SEC is scrutinizing some of these business practices, too little, too late.
In another example, the regulators point to Robinhood’s rollout of a new cash-management feature, accompanied by a wait list for customers to sign up for early access. Customers were given the ability to improve their position on the wait list by “tapping” a fake credit card in the app up to 1,000 times a day, the complaint says.
Increasingly, it seems that competitors are further hopping along the gamification trend, handing out the equivalent of casino comps for trading on their platform:
Webull traders can spin a virtual Wheel of Fortune for a chance at Tesla stock. There are other “awesome” prizes, including a $5,000 gift card and Apple products such as an iPad. In a previous promotion, Webull advertised $2,500 toward a vacation…
The SEC seems to take the view that incentivizing user sign-ups goes hand in hand with seeking payment for order flow (PFOF) revenue. Granted, companies like Robinhood don’t make money outside of PFOF or crypto fees, but I find it hard to believe that any of these retail brokerages are looking for anything other than market share.
By the end of January 2021, some funds had closed out their short positions in meme stocks, realizing significant losses. In contrast, some funds that were long GME saw significant gains. Some investors that had been invested in the target stocks prior to the market events benefited unexpectedly from the price rises, while others, including quantitative and high-frequency hedge funds, joined the market rally to trade profitably. Staff believes that hedge funds broadly were not significantly affected by investments in GME and other meme stocks. Staff did not observe that any advisers to private funds and registered funds experienced liquidity issues or difficulties with counterparties.
As noted months prior, it was pretty obvious that sizable trade prints were coming in from non-retail sources.
You might also remember how on the initial surges, the price rose to around the highest available strike price then immediately plummeted. I speculated at the time that someone was shorting the calls, lifting the stock, buying puts, and then liquidating the entire block at the top and covering the options in the frenzy that ensued. With proper execution, as any HFT firm would have, this trade would be easy to repeat as long as you had eager retail traders reacting to the price prints and providing spread-insensitive liquidity.
Another possible explanation could be a “gamma squeeze,” which occurs when market makers purchase a stock to hedge the risk associated with writing call options on that stock, in turn putting further upward pressure on the underlying stock price. As noted above, though, staff did not find evidence of a gamma squeeze in GME during January 2021. One of the main drivers of a gamma squeeze is an influx of call option purchases, which causes market makers to hedge their writing of the call options by purchasing the underlying stock, driving up the stock price in the process. While staff did find GME options trading volume from individual
customers increased substantially, from only $58.5 million on January 21 to $563.4 million on January 22 until peaking at $2.4 billion on January 27, this increase in options trading volume was mostly driven by an increase in the buying of put, rather than call, options. Further, data show that market-makers were buying, rather than writing, call options. These observations by themselves are not consistent with a gamma squeeze.
This paragraph has a lot to unpack - namely, it’s hard to assume exactly how the inventory was being managed by any market maker without being privy to their internal models themselves. What does strike me as interesting is that according to the SEC, the dollar volume on the puts was as high as the calls. I was expecting more of a skew towards the call side, yet the data would show otherwise:
“Gamma squeezes” cannot happen without a short squeeze of some kind - whether covering the underlying or covering short volatility or a margin call or something. The trading volume was so ludicrously high on both sides of the options chain that I can’t imagine there was significant inventory risk being held in real time - my guess is a lot of orders were being routed internally and calls were being bought underneath parity to hedge against the potential surge (as everything was trading completely out of whack, it was pretty easy to get filled underneath intrinsic value assuming market maker-level execution). Remember, in a thin book, a strike price is guaranteed liquidity at a price - if you are seeing a surge of orders in a book which is seriously lacking liquidity, being able to guarantee a price that you can get filled at to execute makes a lot of sense. Thus, it makes sense to hold calls rather than stock inventory which could ping-pong any which way.
The vast majority of GME stock trades executed off exchange in January 2021 were internalized (approximately 80%) as opposed to executed on ATSs.99 The market for internalization of GME was highly concentrated, with 88% of internalized dollar volume in January executed by just three wholesalers.100 Citadel Securities accounted for nearly 50% of internalizer dollar volume during the month, rising to as high as 55% of daily internalized dollar volume twice.101 Virtu Americas accounted for approximately 26% of the internalized volume during January.102 While the percentage of GME trading internalized declined during the last week in January, the absolute volumes executed by internalizing firms during the days of the most intense trading in this period were, in some cases, an order of magnitude larger than what had previously been typical for these firms. For example, Citadel internalized an average of just under $37 million of GME per day in December 2020.103 On January 27, Citadel internalized nearly $4.2 billion of GME.104 Similarly, Virtu internalized an average of $23.4 million of GME each day in December 2020 and $2.2 billion of GME on January 26.105 On January 29, Citadel internalized approximately $2.2 billion of GME stock, while Virtu internalized approximately $1.4 billion.
The internalizing of this many orders seems to support the conclusion of the prior paragraph: retail was buying and selling calls frenetically back and forth to each-other and their orders were bought by Citadel and Virtu and filled between retail traders themselves. The other half of the story is manipulative traders lifting the stock and pushing the price around on book with no depth, along with squeezing some fundamental shorts on an overly-shorted name. I guess the only question that remains for me is whether the first run up on GME was orchestrated or if it truly was retail discovering the gold mine first - I am positive that all the other “meme stocks” were the result of manipulative trading first and retail frenzy second. If Netflix can figure out how to psyop their series’ into the zeitgeist, surely a secretive hedge fund could have done it with a stock…?
On that note…