GameStop and the Dangerous Game of Gamma Squeezes

The past year has created an interesting market dynamic. It reminds me of the movies A Bug's Life. I understand if that one doesn't ring a bell. It wasn't one of Pixar's best offerings but there's an interesting lesson in the movie.

For as long as the ants (protagonists) can remember, they collected food for the grasshoppers (antagonists). Each year, the grasshoppers fly in, eat the food, then leave. If the ants don't do it, the grasshoppers tell them they will be punished. Eventually, the ants realize they significantly outnumber the grasshoppers. If they band together, they can take down the grasshoppers.

Take that same idea and replace ants with retail traders (like us) and grasshoppers with institutions and market makers.

There's been an awakening. A large group of retail traders have realized if they work together, using market tools such as out-of-the-money call options or low-float stocks, they can overpower any institution or short-seller in the world, outside of the Fed, of course.

We've seen this play out it names as big as Tesla (TSLA) to the current stock du jour GameStop (GME) .

In all fairness, I haven't done much digging into the current fundamentals and upside with GameStop, so I won't claim it is wildly overvalued or still undervalued, but on the surface, I haven't seen enough to justify a move from $5 in September to $60-plus Friday. In the last two weeks alone, the stock has gone from under $20 to well over $50.

The biggest news I've seen is Andrew Left posted a video about shorting the stock then was met with the ire of social media. I did watch the short video. Overall, it was uninspiring in terms of the short argument and I found it very unlike Citron. The argument was a high-level valuation, dinosaur business rather than the usual fraud arguments we see from Left.

But I found the reports of longs attacking Left personally to be a bit unnerving. Playing a harmless joke is childish but it is what it is. However, threatening personal harm and staging internet attacks to take down websites crosses a line for me. Folks doing that are no longer just traders with an opposing view. They aren't even bullies. At that point, they become criminals utilizing intimidation tactics.

I've clashed heads with Citron in the past on some ideas and agreed with others. I certainly haven't always liked their tactics either, but this development is troubling. What's even more troubling is I'm hearing from other sources that attacks on Left and Citron aren't the end of it. At least one additional bearish author I know also suffered cyber-attacks.

Using the tools of the system, basically supply and demand, options, etc. makes sense. Crossing into these kind of activities makes these folks no better than calls against people for insider trading, in my view.

But there's another level of danger to the gamma squeezes. This involves the relentless, high-volume buying in low-priced far out-of-the-money call options to drive a stock price higher by forcing the market maker to purchase the stock as protection against their selling the calls, assuming they can't find another party to take the risk. For market makers unable to pass the risk, they could soon find themselves out of business. We could also see market makers begin to abandon stocks.

What becomes of a name like GME if we take away the gamma squeeze? Now amplify that. Multiple market makers walking away from multiple stocks.

Will it happen? I hope not, but we're all now involved in a very dangerous game.

At the time of publication, Collins had no positions in any securities mentioned.