RV Blog Short Squeezes and Reckless Leverage

Short Squeezes and Reckless Leverage

Short squeezes have destroyed many traders on the wrong side and provided fabulous wealth to many on the right side. Marc Cohodes of Alder Lane Farm joins Jason Buck of The Mutiny Fund to discuss why market participants shouldn’t actively seek stocks with high short interest and why an overleveraged market is a dangerous thing.

The GameStop Short Squeeze

GameStop is a company whose best days have passed as the video game moved digital and brick & mortar physical game sales became passe. Melvin Capital, an investment fund, had an oversized short position that was exploited by traders in the Reddit Forum WallStBets with short-term out-of-the-money call options. 

“These guys made so much money on the GME trade, the arrogance of Plotkin, and Melvin, and SAC, they should have just covered the thing and moved on,” Cohodes stated. “They let the thing hang around. It started going up. I don’t know if they shorted more this, that, and the other– they should have just covered it when it $3, $4, $5, $6, whatever and been done with it.”

Cohodes sees this an indication of a much larger and potentially systemic problem in the market. When two other firms bailed out Melvin, Cohodes felt that sent the wrong message and the market “will learn the lesson that you’re not too big to fail.”

WallStreetBets Took On Wall Street

Excessive Leverage

There are a number of named hedge fund managers who have made billions. Marc doesn’t think there is anything special about their investing technique as “the only way they have money and have made their fortunes is through use of excessive leverage.”

Marc believes this use of excessive leverage is creating systemic risk in the markets with catastrophic fallout for everyone. To remedy this, Marc favors a premium that these funds, banks and firms should pay in order to play.

“Everyone who’s viewed as financially significant should pay a huge tax up front so that you, and I, and fellow taxpayers don’t have to pay extra taxes or run a bigger deficit to bail these guys out.”

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A Different Type of Short Seller

Cohodes draws a fine line between the leveraged buy-sell funds like Melvin and short sellers like himself, Jim Chanos and others. The role many short-sellers traditionally has been one of market investigators – find the fraudulent companies and expose them to the market’s benefit. When journalists and regulators are unable to discover certain information, traditional short sellers shed sunlight on the situation. Sellers like Cohodes have exposed companies like Valiant, Concordia or AAI Farm.  Unfortunately, the upside reward for fraud has tipped the balance in favor of the fraudsters.

“This is very sad for me, but you can’t under the current circumstances run a business where names can go up between 5 and 100 times on you in a week. There’s no way to hedge yourself against that kind of existential risk.” 

For more content on short squeezes, check out some of our other videos with Raoul Pal, Jim Chanos and more.

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