GME Saga explained
Hi again this is Viram from Vested. A lot of us have heard about what happened in stocks like GameStop and AMC. We know how the retail investors battled against the hedge funds that had short positions in these stocks. But today, we wanted to talk about why certain brokers, including our partner drivewealth, had to halt buying in these securities, something which is a very rare phenomenon.
A lot of people thought that the brokers halted this buying because they wanted to side with the hedge funds, but that is not true. The broker had to stop buying because their clearing firm told them to do so. Now the clearing firm had to instruct the brokers because the DTC, which is the primary settlement company in the US, overnight increased the capital requirement from these clearing firms by up to 250 percent. That means that overnight these clearing houses had to scramble to arrange for billions of dollars.
So, why did the DTCC suddenly increase the capital requirements?
Well, this was to make sure that the brokers operate within the confines of their balance sheet. In volatile markets, deposit requirements can vary significantly and depend on different factors such as
- The imbalance between buys and sells offer of a security
- The volatility of a security
- And the volume of that security being traded
As we all know with stocks like GameStop and AMC all of these factors were out of the ordinary.
So that was a quick download on why brokers faced widespread disruption over the last couple of weeks.
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That something big is the Gamestop saga. Today we’ll talk about how Gamestonk happened and importantly why brokers including our broker partner Drivewealth had to halt buying of certain stocks – a rare phenomenon.
Gamestop’s story is a battle between retail traders (specifically folks at WallStreetBet) and hedge funds who had short positions in stocks such as GME, AMC, and others.
Here’s a high level summary:
- Hedge funds had opened short positions on certain struggling companies. A short position is a bet that the share price will decline in the future.
- By taking a short position, investors borrow stocks to sell now, with the expectation that the stock price will decline.
- If the stock price declines, these investors then can buy it at a lower price, return the shares that were borrowed and pocket the difference. But if the price goes up instead, they have to buy the stocks at a higher price to cover the initial loan. And because share prices can rise without an upper limit – the losses can be unbounded
- In contrast, retail traders were placing bets that the stock will increase in the future. Either through buying the stocks outright, or buying options on margins, amplifying the trade volume. After gaining mainstream recognition, more and more retail traders joined the foray, pushing these stocks even higher.
- As the stock price edged higher, the hedge funds got squeezed. They have to buy back stocks at a higher price to cover their initial short position.
- This became a game of chicken, but undoubtedly the retail traders were winning, placing the hedge funds in a difficult liquidity position.
The additional volume and volatility caused stress in the market. Nasdaq stopped trading on GME 19 times in one day – as the share price repeatedly hit the volatility circuit breaker.
The extraordinary volumes in these stocks also caused brokers to block buying in some of these securities. A lot of people felt that the brokers were doing so to side with the hedge funds and stop the retail investor march. However, that’s not true.
The brokers had to block trades because the US clearing firms made them do so. The clearing firms in turn had to do so because the DTC, the DTC is the primary settlement company in the US, overnight increased the capital requirements for clearing houses, not by 10-15% but by 250% in some cases. This means that the clearing houses had to overnight scramble to arrange for billions of dollars.
And why did DTC increase the capital requirements? This is to ensure that brokers operate within the confines of their balance sheet. In volatile markets, deposit requirements can vary significantly, depending on several variables including:
- Imbalance in Buys/Sells in a particular symbol
- Volatility in a particular symbol
- Volume of the symbol being traded, among other factors
That was all on what’s currently playing out in the US stock market. Stay tuned for more!