September 22, 2023

The WallStreetBets Reddit forum on a smartphone in Sydney, Australia on Thursday, January 28, 2021.

Brent Lewin | Bloomberg | Getty Images

What’s next for the Reddit crowd? Wall Street seems unsafe.

The “blow-out-the-short-seller game” is showing signs of exhaustion, but the effects are only just beginning to be felt.

What traders can’t agree on is what will happen next. There are four areas of discussion: How will traders / hedge funds react? How will trading platforms react? How will regulators react? And what’s the next step for the kill the hedge fund traders?

How will Wall Street react?

A big hedge fund losing money is getting Wall Street’s attention. Wall Street doesn’t want to put itself under pressure again in this short squeeze game. Many short sellers like Melvin Capital have already ended their short sales.

Another reaction from traders could be to increase option prices, especially on call options with no money.

But many are still trying to take advantage of the game. “Anyone who knows anything about options is trying to figure out how to sell GME options,” said Larry McMillan, options advisor at McMillan Advisory.

Why? “There haven’t been too many short bruises like this one in recent history,” he said. “As long as people think basics are important, they’re going to be selling short things like GameStop.”

He noted that with GameStop stock trading at $ 260 after close of trading on Thursday night, the $ 260 call expiring on February 19 will sell for $ 107, meaning it would have to be above $ 367 to cash to earn. The put at the same strike price sells for $ 150 so it would have to drop below $ 110 to make money.

“The question is, how do you do that without leading the way to ruin?” he said. “It’s very risky, but definitely possible.”

How will trading platforms react?

Online brokers like Interactive Brokers and Robinhood have slowed down single stock and option trading for many of the heavily shortened names. TD Ameritrade increases margin requirements and prevents short circuits on these names. Robinhood said the decision to restrict trading was a risk management decision to “meet financial requirements, including the SEC’s net capital commitments and clearinghouse deposits.”

While Robinhood has received significant criticism from many traders for its actions, Charles Dolan of the Global Markets Advisory Group said the online brokers are at significant reputational risk.

“When I’m the CCO [chief compliance officer]I will be very conservative and overreact rather than underreact because it is easier to hold off a disgruntled customer than fend off a disgruntled regulator, “said Dolan, whose company provides strategic advice on market structure and regulatory compliance.

Robinhood said it would resume limited trading in previously restricted securities on Friday.

How will regulators and Congress react?

You know that when ultra-liberal MP Alexandria Ocasio-Cortez and arch-conservative Senator Ted Cruz agree that there should be hearings about Robinhood’s decision to ban retail investors from trading, it is an odd situation.

Rep. Maxine Waters, D-Calif., Chair of the House Financial Services Committee, and Sen. Sherrod Brown, D-Ohio, new Chair of the Senate Banking Committee, announced that they intend to hold hearings.

UBS’s Art Cashin suggested that this could be a rich source of investigation: “The chatbook revolt against the hedge funds may not be filled with little people, but some bigshots anonymously posing as the little people. Only one investigation will to do.” say.”

For regulators like the SEC, FINRA, and the CFTC, this is a far more sensitive issue that cannot easily fall back on political grandeur.

“Regulators need to figure out how to remove the incentive.” said Amy Lynch, a former SEC compliance officer who now runs Frontline Compliance.

“Exchanges could get into options trading and restrict it by setting position limits or other restrictions, but they would need to investigate which market rules need to be changed,” she added. She noted that restrictions and even outright bans on short selling are not uncommon: Europe introduced a ban on short selling at the start of the pandemic.

Dolan stressed that a strong regulatory response is urgently needed: “Otherwise the idea of ​​a fair and orderly market is in trouble. If value is separated from price, what do you have left? The idea that people can stay insane longer than. ” Other people can stay liquid. This is a problem for the idea that a market is there to get accurate pricing information. “

What do you have left when value is separated from price? The idea that people can stay insane longer than other people can be a problem for the idea that a market is there to get accurate pricing information.

Charles Dolan

Global Markets Advisory Group

An obvious source for the review is whether to tighten the rules on borrowing stocks. “Does it make sense for someone to sell a stock with more shares than it has listed?” said Lou Pastina of the Global Markets Advisory Group. The SEC could also curb naked short selling, the illegal practice of selling short without first borrowing the security.

What’s this?

Is that a movement? If so, what is the goal? If the goal is to tie it to hedge funds, the idea of ​​targeting short sellers should not be kept faithful. It’s just a means to an end. This will eventually stop working and it will be necessary to move on.

But next to what? Some believe there will be attempts to address other vulnerabilities, others believe that the community will transform into something else.

Stephen Mathai-Davis, who runs the all-AI trading platform, has interviewed thousands of online investors from various Facebook, Instagram, and Redditt communities, including WallStreetBets.

While he denies the idea that it is a real “movement,” he says there are many common characteristics.

“They are definitely countercultural,” he said. “There is a movement in the decentralized online communities where people learn from each other. There is a distrust of Wall Street. They are well aware that Wall Street thinks they are ‘stupid money’. In the community nobody talks about mutual funds, they talk about individual stocks and ETFs. Some are very involved in options trading. “

When interviewing this community, Mathai-Davis asked how much they trade, how they research, and what they need help with.

“We found that they need help with three things. First, they don’t know how to trade in a dynamic trading environment. Second, they don’t know how to reduce their losses. Third, they don’t know how to weight portfolios. “

Mathai-Davis is trying to get the “community” to move away from trading stocks and start trading investment themes. “We believe in investing and not speculating in individual stocks. If you don’t have time to research, we can provide this,” he admits that retail investors continue to focus on individual stocks.

Ultimately, he believes the community is changing: “Instead of using an old-fashioned mutual fund, everyone will end up having a separately managed account that is a bespoke solution. I think that’s where the ‘movement’ is going.”

Subscribe to CNBC PRO for exclusive insights and analysis as well as live business day programs from around the world.