The worst mistake investors can make right now

Actions of GameStop (NYSE: GME) have seen astronomical ascent recently, as short press and gamma pressure combined to force a lot to buy its stocks. While those who bought early in anticipation of such a result may be quite seated right now, current investors should be wary. Cutbacks like this rarely end well, and the same forces that made his actions soar can cause his actions to drop just as far, just as fast if not faster.

Indeed, the worst mistake GameStop investors can make right now is to assume the party will continue. It probably won’t, and those who invest believing it will be the ones who are hurt the most when it all comes crashing down. There is at least two huge risks facing the actions of GameStop that can bring the whole thing down. Failure to recognize them will cause problems for those left in the bag when the whole house of cards collapses.

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The options at the center of this gamma compression

The very stock options that helped compress the gamma upward could end up fueling the downside collapse. Here’s why. On Friday, January 29, GameStop stock closed at $ 325 a share. According to data from Nasdaq.com, the following call options, close to the money, but still in the money, still appear open at market close:

• 7,835 contracts at $ 320 per share.
• 855 contracts at $ 310 per share.
• 1,170 contracts at $ 300 per share.

When options expire in the money, brokers usually automatically exercise those options on behalf of their clients. And that’s where the risk begins. Once exercised, each of these option contracts obliges the holder to purchase 100 shares at the exercise price of the options. These three options contracts alone require people to buy 986,000 GameStop shares this weekend, for a total investment of $ 312,325,000.

Image source: Getty Images

To give you an idea of ​​the scale, a single contract at $ 320 requires an investor to pay $ 32,000 to buy the shares at expiration. At some point between the market close on Friday January 29 and the market open on Monday February 1, affected former GameStop options investors will wake up to find that they are now shareholders of GameStop. Not only are they now shareholders, but they have exceeded tens of thousands or hundreds of thousands of dollars or more.

If these investors do not have the purchasing power of cash or margin to complete the purchase, their brokers will issue a margin call and forcibly close those positions by selling GameStop shares. Just as buying stocks and options has forced the short squeeze and gamma squeeze up, the mandatory sell, initiated by the broker, resulting from margin calls could force the process to reverse.

When a broker forces a sell due to a margin call, that broker does not care about the price of the underlying asset. All the broker cares about is getting the account within regulatory or contractual limits. This is a strong, structural mechanism as to why short and gamma presses are such dangerous double-edged swords that can be reversed as easily and quickly as they form.

Even though these new GameStop investors don’t have to exit their positions due to a margin call, many of them may decide to sell anyway. After all, it’s one thing to bet a few hundred dollars on an option, but it’s another thing to find yourself pledged tens of thousands of dollars (or more) in a highly speculative stock position.

Beware of the personality cult

Beyond the structural mechanisms of short and gamma compressions, GameStop investors face another risk, more related to personality. At the center of the mania is a single Reddit poster (whose online username cannot be reprinted in a family post), which has regularly posted its investing progress on the stock.

The risk does not come so much from his the postings, which largely consisted of simple screenshots of the position and value of his brokerage account, but rather the mass of those who followed him. Comments from the community in response to his posts are peppered with sayings like “if he’s still in it, I’m still in” and all kinds of references to “stick to the man”. These are not the words of rational, valuation-oriented investors, but rather people caught up in an emotional movement or a commitment to a person.

Emotional investing can work for a while, but it rarely ends well. First, those who followed by buying all of the calls that caused the gamma compression may not have fully recognized the financial commitments they made in purchasing those options. Their fanatical engagement can quickly wane once they realize how far they’ve really reached their own pockets to take part in this movement.

Even if that doesn’t cause the stock to fall, at some point the Reddit poster will decide that it has gained enough wealth from this particular speculation and reduce or close its position. His position – 50,000 stocks and options to buy another 50,000 – is only a small fraction of the daily volume of the stock and may not be enough to move the market on its own. When he sells, however, any “if he’s still in it, I’m still in” investors will likely rush to sell as well.

With the leader and the mass of followers not far behind, what is left to hold back the stock or keep those short, gamma pressures of quickly reverse? Worse yet for those who follow, many of those who hold on just because the original poster still stands will find out how the market can turn the other way. Profits on paper can quickly turn into very real losses, especially when the drivers of the initial movement in one direction become the drivers of movement in the opposite direction.

It’s not a question of if, but rather when

Short presses and gamma pressures eventually run out of steam. Whether it’s because of options expiration mechanics, the person in the Eye of the Storm deciding they’ve taken enough advantage, or some other reason, GameStop momentum will run out as well.

Investors who hold because they think they are really going to make money from the continuing trend risk being the poster children of falling victim to the Biggest Fool Theory. They even run the risk of losing everything they’ve invested – or even more, if margin is at stake.

If you are investing in GameStop stocks or options, consider the very real and incredible risks you face and plan and act accordingly. It is highly likely that this holiday will not end well, and those who are most euphoric now are likely to suffer the most when it ends.