2020 has been a hell of a year in the financial markets. We’ve seen the lowest of lows in February and March and what feels like the highest highs in the “recovery.”
We have also seen some very unusual events in the financial markets that are worth recapping. In 2020, we’ve seen:
The comeback of the SPAC (Special Purpose Acquisition Company)
Tesla 6x off the bottom
For that matter, every electric vehicle stock double at least
Hertz quadruple after declaring bankruptcy and then attempt to sell equity while currently in bankruptcy court
Palantir add $25b of market cap in about 4 days
Oil close trading at minus $40 per barrel
The birth of the ‘printer goes brrr’ meme
Kodak go from $2 to $50, only to lose it all shortly thereafter
Softbank outed as the Nasdaq call buying “whale”
There is no way to describe this other than to say that 2020 is the year of r/Wallstreetbets. They seem to have had their hands in most all of these events.
What is Wallstreetbets?
For those of you who are unfamiliar with Wallstreetbets (WSB), it is a community of approximately 1.6 million as of today, who describe themselves as ‘degenerates’ and who happen to love the financial markets and are ever in search of ‘tendies.’ It is really something.
WSB is a dispersed community of people, primarily younger people, who are best described as being on a collective adaptive educational journey. There is also a zealousness about the journey that is infectious. These kids have made the markets fun again and I love it.
I think the word adaptive is appropriate here because the community has evolved over time. Much like in a religion, there are WSB virtues and sins. Only in this case virtues are ‘sick gainz’ or ‘tendies’ and sins are ‘losing your whole account.’
WSB exerts a form of public pressure on community members that lauds strategies and trades that work when done collectively. Through their pseudo religious convictions, WSB have essentially ‘goal-seeked’ into what works on Wall Street to the dismay of the rest of us. (To that I say good on them, by the way.)
Goal Seek To Profit
Let’s describe this a little bit better.
WSB exists as if you were to give someone with absolutely no knowledge of the market an infinite sum to manage with the task of figuring out something (anything!) that works. That something does not need to be logical. That something does not need to be considered industry norm. That something could even be idiotic on the surface.
WSB has delivered. Just look at these posts:
This video is hilarious and it shows they praise winning trades and learn collectively from mistakes.
It is not uncommon to see WSB acolytes pile into what are perceived to be the riskiest of trades. Calls on stocks trading at 100x enterprise value to revenue? Sure, no sweat. Weekly out of the money calls with 4 days left to expiry? No problem at all. Bankrupt equity looking to do an unprecedented equity offering while currently in bankruptcy? Load the boat.
WSB in essence has tried every trade type that your average Wall Street trader/investor/analyst would never do. While most trades end poorly, some have really worked. There are examples on WSB of account holders showing gains into the 8 figures. I think there is something to these ultra-contrarian trades that have enabled them to exploit some of our market structure.
When I say the community is adaptive, they tend to do more of what works and less of what doesn’t, which has been key for their survival.
Hacking Wall Street
A common trade type on WSB that seems to work persistently is the mass buying by the collective of out-of-the-money (OTM) calls on various equities. The lower free float, the better. I have seen this enough now to declare the following: They have hacked Wall Street in this regard.
Given the rise of passive investing (which is now something like 45% of the entire market) and the importance of fund flows to the general market algorithm, the market is far thinner than people may realize. It is this thin market and general lack of active (i.e. aware, alive, non-robotic, etc) buyers and sellers on the margin that has enabled WSB’s OTM option brigades.
I contend that WSB is a consequence of the current market structure, which has accidentally enabled their goal-seeked market hacks and rendered older regimes of market thought inert. Not to mention that zero fee trades have become the norm across brokerage platforms. This is yet another key element to exploiting the thin market structure.
Think about it. If you have 1.6 million ‘degenerates’ each with $10,000 in their Robinhood accounts (or even $1,200 of Trump Bucks) and these ‘degenerates’ are actively buying OTM calls, even if 1% of them participate that’s a lot of marginal buying power.
Imagine being the poor option market maker at Citadel or Susquehanna. You might suddenly see $250 million worth of notional buying activity happen in OTM calls in minutes for no apparent reason. Then, as a market maker what do you have to do now that you are short $250 million notional of some stock via options? Delta hedge.
In this case, that means you have to buy the underlying stock. As the stock rises, the option delta rises, which requires more buying by the market maker - a virtuous cycle. WSB just took what could have been a relatively small sum of money, multiplied it once via options and then again via the option market maker.
In essence, WSB can become the tail wagging the dog. It’s brilliant! And more than that, it is so ultra-contrarian that no traditional market participant (except Softbank) would ever consider doing this. This is what I mean when I say they hacked Wall Street.
Considering how thin some stocks can be, it is no surprise we are seeing parabolic moves driven by underlying call buying.
Here is an example:
Guess who has been chatting a lot about PLTR lately?
WSB has likely taken some of these option market makers and turned them into Pavlov’s market makers. In not too long a time the WSB crew may not even need to buy the OTM calls, they may just need to think about buying OTM calls!
Stock Market Populism
In today’s markets, which appear overrun with monolithic institutions and the same passive investing products that differ in name only, there is little room for individualism. Individual voices are drowned under titanic “fund flows” and the like. WSB represents the chaotic beauty of populism brought to the markets. In fact, WSB may be the first incarnation of a populist stock market movement ever seen.
It is also important to note that they are a decentralized collective made up of independent economic actors. That’s why I describe them more like a religion or even an unruly crowd because if they were centrally controlled they would be committing securities violations.
Given that they are individuals who are loosely coordinated at best, their actions resemble a true market, albeit one operating within the confines of our passive-heavy and institutionalized structures. It is a true market playing within a tilted set of rules; hence the extremely odd and illogical goal-seeked trade types.
In an odd way, WSB is not the active management we want, but the one we deserve.
We have seen something else odd happen in 2020. Some traditionally very successful investors appear to be having difficult years while WSB appears to be thriving, although it is hard to know the exact tally.
For instance, Renaissance Technologies, which is the greatest hedge fund firm of all time and was reported to have been having a great year through April, is now said to be down roughly 20% on the year. That is quite the reversal in fortunes. It seems the rise of the ‘Printer goes brrrr’ meme on WSB was coincident with some of RenTech’s algorithms breaking down.
This begs the question, did WSB beat Jim Simons and his cast of eggheads? Perhaps their algorithms never planned for or saw stock market populism. Perhaps their algorithms have themselves goal-seeked into a market structure that broke down in 2020. Perhaps this is an aberration.
All I know is that I enjoy the WSB crew. They bring fun to the market that we have needed for a long time. I increasingly respect what they are doing, which is finding and exploiting (even the craziest) inefficiencies in the market. And finally, I hope to find myself in one of their names as early as possible.
Until next time! -Dubra