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This week: Wealthy Populists; Shorting; Tesla Options; The Boom in Certainty.
One of the more intriguing parts of the GameStop story is the rush of some very wealthy business people to side with the small investors of WallStreetBets and to stoke the rebellion of what they call the little guy against the big bad Wall Street boys. Lest we forget, the main source of these people’s wealth, entrepreneurial as they may be, is in the end the very stock market that they deride falsely as the exclusive playground of hedge funds and other allegedly nefarious manipulators.
Hedge funds in fact hold a small slice of the market and households hold the biggest part. Foreigners, pension funds, ETFs and mutual funds hold the rest and all are ostensibly deemed respectable by WallStreetBets members. It is true that hedge funds are the main actors who engage in shorting and that they are more active in daily trading. But neither of these features should damn them in the eyes of the public.
As to democratizing access to the markets, this was done long before Robinhood came on the scene, as long ago as the 1980s and 1990s. It has been possible since then to open a retail trading account with a modest sum of money and to trade at near zero brokerage costs. A large share of American workers also own stock via their retirement plans, IRAs, 401(k) and the like. If Robinhood stands out now, it is in part for having been more permissive in the trading of options, a decision that led it into hot water with some regulators long before the latest developments.
It is a stretch for WallStreetBets to claim that it represents the little guy. That guy has no money to risk in the stock market and if he did, he is unlikely to risk it chiefly in order to hurt some far-off hedge fund. Similarly, the super rich cannot realistically claim to stand up for the little guy in the name of equity. When they do so, it is generally due to other motives, all of them rational from their point of view.
Another recent debate is about shorting stock and the kind of people who short stock. The more extreme detractors argue that shorting is un-American because, well, America runs on optimism and shorting is a sign of pessimism. True, but American optimism is contingent on cohorts of people laboring daily on discovering the truth, whether that truth is in science or whether it is in the accurate pricing of assets. Further, general optimism about the economy is not incompatible with pessimism about a handful of companies. Not every company is going to be lifted by the rising tide. The process of creative destruction entails the disappearance of some and the emergence of others.
Shorting is not just defensible, morally and practically; it is completely necessary. In fact, there is not nearly enough of it. And because there is not enough of it, most stocks are perennially mispriced in the market. In addition, large cap stocks are arguably more mispriced than smaller ones because analysts and money managers are influenced by the constant feedback that they get from the market and from their peers. Read about this dynamic in Large Stocks are Widely Mispriced.
The roadside of stock investing circa 2020 is littered with the skeletons of investors who shorted Tesla. But while we are on the topic of shorting and options, it behooves us to look at Tesla options. As noted by market strategist Lawrence McDonald, Tesla options are priced at levels that treat its current price as unsustainable. With most other stocks, at-the-market options two years out are priced at somewhere between 10 and 20% of the underlying stock.
But with Tesla trading near $850, an at-the-market call or put will set you back $350, or roughly 40% of the stock price. This means that an option investor will not make money at expiration unless the stock moves at least $350 up or down. This elevated option price is a reflection of Tesla’s large move in the past fifteen months but it also denotes lack of confidence in the stock’s current level, be it too low or too high. With momentum on its side and more stimulus money coming soon, Tesla stock could be too low. But based on valuation, it looks too high.
The Boom in Certainty
We recently published The Boom in Certainty. Sinclair Lewis called it “the sedate pomposity of the commercialist”. And now it has spread to many parts of society, not always in its sedate form. Read it here.
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