Jan 28, 2021 - Economy & Business

r/WallStreetBets administrator pens open letter to CNBC about hedge fund leverage

Screengrab of post on r/WallStreetBets from an administrator
Screengrab of post on r/WallStreetBets from an administrator

A major aspect of the rise of stocks like GameStop is the use of leverage by hedge funds. The r/WallStreetBets crowd is using that leverage against them.

What it means: Because hedge funds are using borrowed money to place bigger bets, they have to exit positions at certain levels or risk losing potentially infinite sums of their clients' money and their own on short positions.

  • Conversely, call options, especially those that are far out of the money (above the stock's current price), are cheap. This gives the Reddit crowd an advantage.
  • Those leveraged positions also provide a tailwind because they help de-anchor a stock's price once a highly levered hedge fund has pulled out of its position.

The bottom line: Melvin Capital, which had vociferously taken a short position in GameStop, closed out that position Tuesday after taking a huge loss and received a cash infusion of nearly $3 billion from Citadel and Point72 to shore up its finances.

Go deeper: Understanding GameStop as a metaphor

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