The last article I wrote on GME was to avoid repeating myself to every single person who was directly asking me what is happening with r/wsb stocks.
A month later, we are having an encore.
Like before, I will only focus on the market microstructure aspect of this pop and leave out the political/social commentary to people who are more well-versed than me.
In the last article, I mentioned that the r/wsb crowd had understood that in order to repeat their epic short + gamma squeeze on GME, they had to find stocks with these three characteristics:
1. High short interest
2. Active option market
3. Illiquid stock
2. Active option market
3. Illiquid stock
In this latest run, the crowd has found another valuable tool in their market microstructure toolkit:
After-hours trading.
I have marked the start of the after-hours trading in GME on February 24th in the chart below. Note the price and volume action after the dotted orange line, we will come back to that later.
GME Stock Price Feb 24–2. Source: Interactive Brokers
First, let us see how those three characteristics have changed for GME in the last month:
1. Short Interest: GME’s short interest is down massively from over 100% of the float shorted to about 30%. That is a huge relief to any short squeeze attempt. While still a relatively high ratio, 1/3 of float sold short is not out of the ordinary.
2. Active Option Market: The option market on GME is alive and well. That said, with periods realizing well over 300% annualized volatility, the options’ implied volatilities are extremely high, and the bid/ask spreads are quite wide. In plain English, this means that the option sellers have substantiality raised the prices at which they are willing to sell options.
3. Illiquid Stock: The stock is more liquid than before, mostly due to the short interest coming down. With a ~50m float, it frequently trades the entire float in 2 – 3 days which is atypical to say the least.
The regular trading session for US equities on NYSE is 9:30am EST (i.e., market open) and 4pm EST (i.e., market close).
The after-hours trading starts 4pm EST and ends at 8pm EST. The most important thing to note about after-hours trading is that the liquidity (i.e., available volume of stock to trade) is far below what trades during regular trading hours as the number of participants drops significantly with reduced risk taking across the remainder.
This drop in liquidity is the critical part that the latest pump on GME’s stock has capitalized on. There clearly is a strong understanding of market microstructure in these moves. It takes an order of magnitude fewer dollars to move the stock price around after hours, but the price is sticky.
This is especially relevant to the option sellers who would have been “hedged” at market close, but overnight have seen the price move enormously against them and now must buy an order of multitude to hedge themselves.
On top of that, there are expiries in option on GME for this Friday February 26th. The option delta (i.e., sensitivity of the option’s price to the underlying stock’s price movement) increases exponentially as you get closer to expiry. A $100 Feb-26 call on GME was virtually trading worthless 3 days ago at around 25c as it was likely going to expire worthless out of the money.
On Thursday, it traded as high as $90 as the stock price blew way past the strike of an option that is one day from expiry.
That is a return of 360x.
$100 Call Strike Feb-26 Expiry. Source: Interactive Brokers
What does this all mean?
It means that the people coordinating on these efforts are smart and have a solid grasp on the mechanics of the market microstructure. They have used the thin liquidity in the after-hours trading to push the price up massively right before the expiry of options.
Is this a problem with after-hours trading?
The after-hours trading is a valuable tool for market participants to manage their risk after the market’s close. Most exchanges have some form of after-hours trading to help market participants access liquidity as the news cycle develops. Like any tool, it can be used for good or bad.
This is not investment advice. All opinions are my own only, and you should do your own due diligence, as always.
Previously published here.