Ep 38: What is a Short Squeeze? (Talking About Meme Stocks, Hedge Funds & Market Mechanics)

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Finally, short squeeze and gamma squeeze make sense! (Did you know gamma squeeze was a thing?)

Also, Roaring Kitty is out of hiding, remember that whole GameStop stonks thing that happened (if not, watch the 2023 movie Dumb Money)? Well apparently it's happening again with GameStop and another memestock called FFIE (super high risk, y'all, don't lose money you can't afford to lose).

We also learn about hedge funds, meme stocks, market makers and the roles played in making money off shorting stocks (or squeezing out the shorters). Check out our ⁠episode on Dark Pools⁠ for more background. We also very briefly discuss Options!

Hedge funds are regulated and here's the link we mentioned for that: ⁠https://www.sec.gov/files/ib_hedgefunds.pdf⁠

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Pre-requisites:

- The market is a function of supply and demand. Are there more buyers than sellers? If yes, that causes the price of the stock to increase. The inverse is also true… if there are more sellers than buyers then the price of the stock decreases.

- Hedge Funds - also in the name: derived from the word ‘hedge’ like the tall bushes to protect your property back in the day. You have to be an accredited investor to have one.

- Accredited investor is defined by Reg D rule 501 (a) 5&6 as a “natural person” with a net worth of 1 million (not including their primary residence) who earned at least $200,000 in the last two years and expect to earn the same in the current year.

- Market makers only want orders, they keep a delta neutral portfolio (remember the dark pools episode? and when we talked about payment for order flow?) All that means is that market makers only want orders, they make the spread, they create a portfolio that does not profit from market movement, only order volume.

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The Takeaway:

Shorting a stock is super risky. You're gambling on the failure of a company, essentially, and this tends to happen in hedge funds. A short squeeze is an event that happens when the people who are shorting stock shares have to cover the cost of the shorted stock because now the price is going up due to unforeseen demand (people suddenly buying it) and getting squeezed out of that position. It's like we always say, investing involves risk. ;)

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Jessie's Questions

1. What is a short stock?

Selling a stock you do not own and speculating on the stock to go down in value. The lingo: you are shorting the shares - it’s in the name! Frequently shorted shares, or shares that are in demand can be designated as “hard to borrow” which means they come at a cost to short.

2. What is short interest?

The percent of shares outstanding that are short, a higher percentage can be indicative of a short squeeze but also gives you indication of negative sentiment.

3. What is reg sho (regulation of short sales)?

You cannot short sell naked. Reg sho (regulation of short sales) was updated as recently as last year, it means that if shares are shorted, they have to be located or “tagged”

4. What is a short squeeze?

Short sellers are forced to buy to cover their positions, creating “demand” often without fundamental reasoning. Rather to cut losses.

5. What is a gamma squeeze?

A big and rapid increase in a stock's price, usually triggered by large trading volumes in one direction within a short span of time by market makers acting as sellers of call options who are then forced to buy stocks to hedge risks. This event typically starts when many investors buy call options for a certain stock. Additional volumes of purchases accelerate the price risethe price rises.

6. What are Hedge funds?

Also in the name: derived from the word ‘hedge’ like the tall bushes to protect your property back in the day. You have to be an accredited investor, which is defined by Reg D rule 501 (a) 5&6 as a “natural person” with a net worth of 1 million (not including their primary residence) AND have earned at least $200,000 in the last two years and expect to earn the same in the current year. Hedge Fund Managers buy stocks to create a delta neutral position as a result of increased speculation. This creates “demand” without fundamental reasoning. Basically, the hedge fund managers are betting that a stock is going to drop in value and short the stock in a way where they buy it for a future lower cost than they sell it and pocket the difference for their client.

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