Short interest in meme stocks drops as hedge funds target call options

The origin story of the meme stock phenomenon centered around an uprising by retail investors, who wanted to make money at the expense of Wall Street short-sellers.

But in today’s meme stock world, there’s not that much short interest in the names most popular with the WallStreetBets crowd. Instead, trading activity appears to be increasingly driven by call options, the Wall Street Journal reports.

Driving the news: Mudrick Capital — a hedge fund that profited from AMC Entertainment trades this year — recently saw its flagship fund lose 10% in just a few days thanks in part to bets on AMC options, the WSJ says.

Why it matters: Though meme stocks are off their highs, they continue to trade at sky-high valuations disconnected from fundamentals. Many, like AMC, GameStop and newcomer Clover Health, booked another day of gains in Friday's session.

How it works: Call options give buyers the right to purchase a specific stock within a certain time period. A buyer of the call option makes money when the stock rises in price.

• An increase in call options activity can force the sellers of the options to buy the stock, since they may have to deliver the shares. This pushes the stock price up.
• The chain of events is known as a gamma squeeze.

State of play: Investors like hedge funds could be buying certain stocks to try to trigger a gamma squeeze, Helen Thomas, founder of U.K.-based financial research firm Blonde Money, told the WSJ.

• Such a squeeze can accelerate a stock's ascent — and also its decline.

The bottom line: “Hedge funds are scared to have holdings on significant short positions [in meme stocks], even if fundamentally it makes a lot of sense,” Lorenzo Di Mattia, chief investment officer of Sibilla Capital, told WSJ.