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GameStop and AMC Entertainment caught the attention of common investors, brokerages, hedge funds, regulators and even federal governments across the world last week.
Shares of GameStop surged from $2.57 on April 4, 2020, to $483 on January 28 — a gain of nearly 14,686 per cent. GameStop Corporation operates electronic game and PC entertainment software stores. AMC Entertainment Holdings, an American movie theatre chain, saw its share price zooming within 20 days from $1.91 (January 6, 2021) to $20.36 (January 28), an astronomical rise of 965 per cent.
What shocked many was that the rise in the share price had nothing to do with the fundamentals of the companies but was prompted by a group of smart retail traders under the description of “WallStreetBets” on Reddit, an American social media platform that hosts news aggregation, web content rating and discussions.
However, as the brokers put restrictions on traders for going long on these stocks following a huge hullabaloo, they fell sharply in the last two days. GameStop dropped to $193 levels and AMC to $8.6.
Modus operandi
The game plan of these investors is very simple. Identify stocks that have huge short positions (much beyond the available free-float) built up by hedge funds and big institutions from public disclosures and start accumulating them. By encouraging a host of other traders to go long on these stocks through social media platforms, they are then able to force hedge funds and the biggies, who have shorted those stocks, to square their positions at a huge loss, which would then be the gain of these retail investors, in this zero-sum game.
GameStop is one such stock shorted heavily by hedge funds and other professional investors of Wall Street. This was what had happened in Tesla Inc, too. Elon Musk, CEO of Tesla Inc, has these retail investors to thank for at least part of the rise in the Tesla share price from the $70 level to $900, propelling him to the top of the world's richest list.
Elon Musk tweeted: “U can’t sell houses u don’t own, U can’t sell cars U don’t own but u ‘can’ sell stock u don’t own!? This is bs – shorting is a scam. Legal only for vestigial reasons.”
Checks and balances
Given the attention it has attracted, can the GameStop saga find echoes in India? These kinds of wild swings will be difficult to engineer in the domestic market, as regulator SEBI and the exchanges have many curbs in place to restrict untrammelled risk-taking. For instance, in the cash segment, naked short selling (selling without owning shares) is banned. Investors must indicate prior to trading whether the transaction is a short-sale or not. If the transaction is a short-sale, then he or she must deliver the shares of the shorted securities during settlement. There are other measures by which exchanges curb excessive volatility in the form of Value at Risk and extreme loss margins. Exchanges also impose circuit filters on stocks that stop their daily price swings at 2 to 20 per cent.
Market-wide limit for F&O
Gross open positions on any given day across all futures and options contracts on an underlying security, for each client, FPI (Category III) or scheme of MF, is not allowed to exceed one per cent of the free float market capitalisation or 5 per cent of open interest in all derivative contracts in the stock, whichever is higher.
Besides, SPAN, upfront and peak margins ensure that there is no systemic risk on the payments side, too.
Trading ban
Also, there is position limit for individuals to take exposure. The combined futures and options position limits are capped at 20 per cent of the applicable market wide position limits. So, any contract that crosses 95 per cent of the market-wide position limit will come under trading ban and can resume trading only if the position limit goes down to 80 per cent.
In index futures and options, there are position limits for trading members/FPIs/mutual funds. They can hold contracts worth ₹500 crore or 15 per cent of the total open interest in the market in equity index futures, whichever is higher.
In effect, with so many rules limiting the extent of leverage and open positions traders can build up, there's not much scope for GameStop-like wild moves on Indian bourses.
Even in overseas market, it is prudent for small investors not to go overboard beyond fundamental levels. If things started normalising, they may have to pay a huge price, which they may not be able to afford.
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