Posted at February 5, 2021 Posted In Uncategorized

I was asked by my two favorite clients, my parents, to explain what the deal was with GameStop (GME). 

Below is an explanation as succinctly as I can manage:

1. Let’s say I want to “short” XYZ which has a current price of $10. I borrow 1 share of XYZ then immediately sell it for that same $10. I now have $10 in my pocket but owe the broker the 1 share borrowed. Now let’s say the price of XYZ drops to $7. I then buy that share at $7 and return that share to the broker. I received $10 when I sold but only paid $7 to buy, so my profit is the $3 difference. 

2. In reverse, say the price for XYZ goes from $10 to $15. To return the 1 borrowed share, it is going to cost $15. In effect, I lose the $5 difference between when I first sold the share at $10 to when I buy it back at $15.

3. Now for GameStop… A few weeks ago, a group on Reddit (a chat room/social platform) noticed a hedge fund (Melvin Capital) took a large short position against GME. These Redditors convinced thousands of people on the thread to join forces and buy as much GME as possible. This made the price rise and the hedge funds short position hemorrhaged billions. 

Melvin Capital had to close their short positions and buy GME stock back at much higher prices, sending the price higher still. This is called a “short squeeze.” The losses surpassed the 13.1 billion the hedge fund was worth forcing the company to declare bankruptcy.

I was asked by my two favorite clients, my parents, to explain what the deal was with GameStop (GME). 

Below is an explanation as succinctly as I can manage:

1. Let’s say I want to “short” XYZ which has a current price of $10. I borrow 1 share of XYZ then immediately sell it for that same $10. I now have $10 in my pocket but owe the broker the 1 share borrowed. Now let’s say the price of XYZ drops to $7. I then buy that share at $7 and return that share to the broker. I received $10 when I sold but only paid $7 to buy, so my profit is the $3 difference. 

2. In reverse, say the price for XYZ goes from $10 to $15. To return the 1 borrowed share, it is going to cost $15. In effect, I lose the $5 difference between when I first sold the share at $10 to when I buy it back at $15.

3. Now for GameStop… A few weeks ago, a group on Reddit (a chat room/social platform) noticed a hedge fund (Melvin Capital) took a large short position against GME. These Redditors convinced thousands of people on the thread to join forces and buy as much GME as possible. This made the price rise and the hedge funds short position hemorrhaged billions. 

Melvin Capital had to close their short positions and buy GME stock back at much higher prices, sending the price higher still. This is called a “short squeeze.” The losses surpassed the 13.1 billion the hedge fund was worth forcing the company to declare bankruptcy.

In a matter of hours, the SEC jumped in and stopped the entire market. When the market reopened, several retail brokers, most notably Robinhood, refused to accept any “Buy” orders. 

As buy orders stopped coming in, the price dropped precipitously allowing larger institutional brokers and hedge funds (who remained active without restriction) to mitigate their losses. 

The real story, however, is far from over. How will Wall Street and government agencies respond in their attempts to “fix” the problem? If recent history tells us anything, more than likely, the solution will hurt the individual investor rather than help.

The underlying confidence in our financial systems is under scrutiny and deservedly so. Even as recently as a few months ago, J.P. Morgan was fined and forced to pay $920 million for manipulating the precious metals and treasury market.

Combine that with the fact that Janet Yellen, who recently accepted $810 million dollars from Citadel for “speaking fees,” now sits at the helm of the largest financial institution on the planet. 

Needless to say, these facts do not exactly inspire trust.

People are realizing that the markets are riggedAnd they’re not rigged in our favor.

Two weeks ago, we went over potentially adding gold, silver and crypto to your portfolio as insurance to safeguard cash holdings. Is diversifying into other tangible assets, like real estate, an idea that warrants further investigation? 

Now, more than ever, is the time to make sure you are financially sound. 

JFK once said, “The best time to fix the roof is when the sun is shining.” Perhaps the second-best time is if you think clouds might be on the way. 

Our mission is to help passive investors become financially-free by providing high quality alternative investments. If we can help you in that way, it would be an honor to do so. Feel free to schedule some time for us to chat. 

Until next time…

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