Thursday, February 18, 2021

"Follow the money": what the Robinhood affair has revealed


Readers will recall the fuss and bother a few weeks ago, when a Reddit investing sub-forum used Robinhood and other low- or no-cost brokers to launch a short-selling campaign targeting certain hedge funds.  To the fury of those investors, Robinhood restricted their ability to trade, and in some cases sold their orders on the open market without their permission, thereby helping the hedge funds keep their heads above water.  Legal action has already resulted, and is sure to be in the courts for months, perhaps years to come.

Tyler Durden sums up what Robinhood did - and, more importantly, why it did it.  Yet again, we see that if a service or product is free, it simply means that you, the user, are the real product.  You're being bought and sold.

Frankly, we've had it with the constant stream of lies from Robinhood and neverending bull**** from the company's CEO, Vlad Tenev.

. . .

What he is referring to, of course, is Robinhood's outrageous decision to restrict the buying of 13 heavily shorted stocks on Jan 28 that had been driven to record highs, including GameStop, whose shares had surged more than 1,600%.

Tenev said the restrictions were necessary due to a large increase in collateral/deposit requirements by the DTCC, but that was not spelled out in automated emails sent to Robinhood customers early on Jan. 28.

And then he decided to pull the oldest trick and deflect attention from his own mistakes by blaming "conspiracy theories."

. . .

What Tenev did not say, or explain, is why his company - which is merely a client-facing front of Citadel, which buys the bulk of Robinhood's orderflow to use it perfectly legally in any way it sees fit - was so massively undercapitalized that the DTCC required several billion more in collateral to protect Robinhood's own investors against the company's predatory ways of seeking to capitalize on the gamification of investing making it nothing more (or less) than a trivial pursuit to millions of GenZ and millennial investors, a point which Michael Burry made so vividly.

Incidentally we know why Tenev did not mention it: it's because Robinhood's back office is a shambles of a shoestring operation, one which never anticipated either such a surge in trading not a multi-billion collateral requirement; had Robinhood been a true brokerage instead of pretending to be one, and run merely to open as many retail accounts as it could in the shortest amount of time, thus generating the most profit in the quickest amount of time to allow its sponsors a quick and profitable exit, it would actually have been on top of this.

. . .

Which brings us to a totally separate topic, and one which Tenev will one way or another have to address: the fact that Robinhood is a de facto subsidiary of Citadel, whose entire business model is to sell retail orders to a handful of HFT market makers first and foremost... Citadel. In doing so the only ones who benefited from the surge in retail trading are Robinhood itself, by pocketing millions more from selling orderflow to Citadel, Virtu, Two Sigma, Wolverine and other HFT frontrunning "market-making" venues, as well as Citadel which made billions by having an advance look at the biggest surge in retail stock and option orders flow in history, and being able to trade ahead of and around it.

And no, it's not a conspiracy theory Vladimir - it is the stone cold truth, as Jeffrey Gundlach suggested last week when he said "Robin Hood (sic) should be forced to change its name to Hood Robbin’.  I grow so weary of lies through nomenclature, which are ubiquitous these days" adding "To be clear, the name change would reflect Robinhood robbing the little guy, nothing else."

. . .

Would it therefore be farfetched to say that Robinhood is nothing more than a client-facing subsidiary of Citadel, one which pretends to offer free trades to tens of millions of young, naive traders, but in reality merely allows Citadel Securities to trade ahead and/or against this orderflow for which it paid over $300 million... and to generate record revenues of $6.7 billion!

Probably not, but we won't have a definitive answer until we find out just how much profit Citadel made from buying all this critical data, which gives it an early glimpse into not only each discrete individual trade but also a sense of which way the retail horde is moving, critical and extremely valuable data which until last August was public and available to all (with a slight delay) courtesy of Robintrack, and which last August was inexplicably halted.

There's more at the link.

As always, the old adage "Follow the money" reveals who's really profiting - and it wasn't the individual investors using Robinhood's services.



Ritchie said...

A low-number rule is, when the trade turns against you, punch out.
Don't hang on, telling yourself that it will get better.

Mike said...

Something I see continually glossed over and/or ignored by most reports is the fact that for many of the followers of Wallstreetbets on Reddit, this was not seen so much as a profit making opportunity, but as a chance to stick hedge funds that were abusing rules and their market position to try to make huge profits. They were ponying up money that money of them stated they fully expected to lose in order to cause massive losses to the hedge funds.

Short trading works by a market player that thinks the price of a stock will drop borrowing shares of a stock from whoever holds them, selling the stock at the current price, then hoping to buy it back later at a lower price and return the stock to the original owner. The short seller pockets the difference in the current price versus the future price if the stock goes down in value, but if it goes up the the short seller must buy it back at the higher price and loses the difference. Borrowing the stock is a loan that the short seller must pay interest on, and the longer they wait before buying the stock back and returning it the more they pay in interest.

Mike said...

In the case of Gamestop the hedge funds had sold short more shares of the company than actually existed. This either meant that every share of the company had been borrowed, sold, then some had been borrowed again, or that some of the hedge funds were engaging in "naked short selling", an illegal practice in which companies sell shares of stock they didn't borrow or own in the first place. With this extreme level of short activity some of the people on Reddit realized that if they could drive the price of the stock up, the hedge funds would have to repurchase the shares at a higher price to close the huge short positions, which would both generate massive losses for the hedge funds and could generate a profit for the people who currently owned the shares, depending on how high the price had already risen when they bought the shares.

Many of the Redditors saw the hedge funds as unfairly attempting to damage a company they had some affinity for (many are Millennials and Gen Xers with fond memories of buying video games at the store), and they are biased far left anyway and tend to see hedge funds as evil. Coupled with the likelihood of naked short selling by these huge players with no attention from the SEC, they started a crusade to punish the hedge funds by pushing the share price up as much as possible to force massive losses on the hedge funds. This was a viral movement of millions of small retail traders buying as many shares of Gamestop as they could - often just 1-20 shares per account. This pushed the price up rapidly, and as the price continued to rise the attention given to the movement began to grow. They appeared to be succeeding early on, with Melvin Capital Management requiring a 2.75 billion dollar bailout from even bigger hedge funds to stay afloat due to the losses on their short positions.

Mike said...

This started a backlash by the hedge funds, and by most of the financial press. They began calling for SEC investigations, etc. claiming the Reddit group was manipulating the market. To some extent, that's true, but only to the same extent the same players and financial press do exactly the same thing to talk about how great a certain stock/sector is or how awful another is to drive movement in certain directions and profit off it. This reaction incensed the Reddit community even further, and brought more small investors on board due to the perception of the market players trying to get the government to step in when someone else tried to use their own tactics against them.

The next step was that several brokerages, with Robinhood being a prime example, suddenly halted the ability to buy shares in Gamestop, although they would allow shares to be sold. This was widely seen as a betrayal of the customers by these brokerages and generated instant lawsuits. The financial press has assumed the lawsuits will be dismissed since the brokerage agreements include the ability to refuse to conduct transactions, but the story isn't that clear. For instance, Robinhood is owned by a financial corporation called Citadel. Citadel was one of the two big players that injected cash into Melvin Capital Management in return for partial ownership when the hedge fund lost billions in the early part of the short squeeze. Robinhood thus had a conflict of interest in disallowing their customers to buy more shares, which violated other parts of their contract.

The reaction to this has been absolute fury on the part of most of the small investors on Reddit (millions of them) whether they lost money or not. It was a naked abrogation of the rules in favor of the major players in response to the little guys trying to use their own tactics and foolish investments against them.

The financial press, government regulators, and traders who are shaking their heads at the foolishness of these small investors in pushing up the price of Gamestop stock are missing the point, and I suspect dangerously so. These guys did want to make money, but the goal of punishing the hubris of the hedge funds was at least as much of a goal. The open display of yet another case of the "elites" uniting to protect their own and force losses on the small guys has driven many of them from left-wing to radical left wing. Membership in groups espousing left-wing gun ownership and violent action spiked at about the same time. This is the kind of behavior by the elites that leads to violence.