DRS Your GME

In a discussion on a post earlier today about how shorts could still be in trouble if the price has come down so much, there was some well-intentioned misunderstanding about the shorts’ predicament. This is a very fundamental point but I’m not sure it’s been adequately articulated, perhaps to some of the newer members.

The claim was that shorts are fine for the time being because they took out more shorts at the top of the sneeze which are massively in the money. While that is true for people who only shorted during the sneeze (Icahn, for example), it is irrelevant for the majority of shorts which existed for years before the sneeze. There are main 2 reasons for this:

1. Size of the short position- the same size short position that was opened at $1 pre-sneeze cannot be opened at higher prices in terms of number of shares.

2. Liquidity- the short position relatively to the trade-able shares is so massive that closing any appreciable short position will not be profitable.

Allow me to explain: A $1M short position at a price of $1/share is a short position of 1M shares. This is the level that the majority of shorts were taken pre-sneeze (post-split numbers). The float was shorted over 100% of outstanding shares. If the price were $1/share, shorting 100% of the company would be $305M (305M shares x $1/share). When the price spiked to all time highs ~$120/share during the sneeze, no doubt more shorts were taken out. But shorting 100% of shares at $120 is $36 BILLION DOLLARS (305M shares x $120/share). That’s not possible to take on that liability. So what does that mean for shorts?

Let’s say someone who took a $1M short position at $1 (1M shares) “doubled down”, because they stupidly thought retail would capitulate. So they open another $1M short position at say $100 to make the math easy. That’s only a 10,000 share short position. So now you are short 1,010,000 (1M + 10,000). Now say the stock goes down to $15 where we are today. Mark to market, that is, on paper, you are up $85/share on your 10,000 shares short at $100, for an unrealized gain of $850k. HOWEVER, you are down $14/share on your 1M shares taken out at $1, which is $14M!! Your break even point on your short position is when the price has fallen 100x further from your high position that it has risen from your low position because you have 100x more shares at the low position (1M vs 10k). So what is that price?

$1 short position loss = $100 short position gain

(Price - $1) x 1M shares = ($100 - price) x 10k shares

Break even Price = just over $1.98/ share

So an identical short position at $1 and $100 has a break even under $2/share because math.

Now to point #2, which as a short makes your situation completely hopeless. Liquidity! Say the price gets down that low and you try to cover with little to no loss. You have over a million shares you need to buy on a stock that only trades a few million shares a day and a third of the company is either directly registered or held by the CEO for eternity. When you start to buy, the stock is going to move. And when it moves, other shorts will start to cover, exacerbating the issue. So how much movement can you tolerate? Well, on your $100 position you only lose $10k for every dollar the stock increases. Not so bad considering you’re up almost $1M at $2/share. BUT for every dollar the stock moves you lose $1M on your $1 short position because you are short 100x as many shares! Granted at $2/share that’s a 50% move, but we’ve seen wayyy bigger days for GME and you’re surely not covering all your 1,010,000 shares in a day. Essentially you are absolutely, irrevocably, eternally screwed.

“But they’ve kept shorting!!!!” you say?! Ok great. This is the dumbed down version of the “line of hedgie nightmares” or “Dorito of doom”. You can keep shorting on the way down. You increase profits on those shorts while eliminating losses on your $1 shorts as the price falls. But what this does is decrease the threshold of price increase you can tolerate. What does that mean? Well if you have the short position at $1 and at $100 but then added more short positions at $50, $20, $10, etc., when the price goes above each of those levels during surges, you are even further underwater than with your original $1 short!! For your homework, write out in crayon what your break even price is if you took out additional $1M short positions at $50, $20, and $10. Now calculate what your liability is at $30 compared to what it was with only your $1 and $100 short position. More shares, more underwater. More losses. And still no hope of covering.

TL;DR entities that shorted pre-sneeze are STILL way underwater in mark-to-market losses no matter how much they’ve shorted since then. They are hiding that liability in derivatives and have no hope of closing their positions.*