- I investigate possible causes of GME and AMC’s epic dump over the past month…
- How options trading may be influencing meme stock price action…
- PLUS — get into the trading course changed my life!
The recent downtrend in legendary meme stocks GameStop Corp. (NYSE: GME) and AMC Entertainment Holdings Inc. (NYSE: AMC) has been unrelenting.
Big picture: In the last 30 days, AMC is down 45% and GME is down 30%. Yikes!
Meanwhile, retail traders are scratching their heads in confusion. If they aren’t selling their shares, who (or what) is causing this massive downtrend in their beloved meme stocks?!
Let’s break down what’s going on with meme stocks (and how the options market may be causing it)…
The Truth About Meme Stock Selling
The truth is, most of the confusion surrounding the meme stock downtrend is due to traders being misinformed. Just because their mom, their friends, and some strangers on Reddit tell them that “no one’s selling” a stock doesn’t make it true.
Like any other stock, AMC and GME are bought and sold every single day. Don’t trust anyone telling you otherwise.
The reason these traders are confused is due to discrepancies between what they see on Level 2 data and the reality presented in the price action. Let me explain…
Over the past month, on days when meme stocks are getting destroyed, the Level 2 data shows a mysteriously small amount of asks. Usually, this means there aren’t a lot of sellers in the name.
But the problem lies in using traditional data to track untraditional equities.
AMC and GME aren’t normal stocks — so don’t treat them as such.
What appears to be happening is that retail traders’ orders (particularly those coming from commission-free trading apps) are being routed to dark pools.
Note: Dark pools are private exchanges that aren’t accessible to the general public. The sale of retail order flow (and the diversion of funds to dark pools) is how commission-free brokerages make their money.
The use of dark pools makes it difficult for the average retail trader to have any idea what’s truly going on in meme stocks’ Level 2 data.
“Mark Croock Uses A Little-Known Strategy to Trade From Home Without Investing a Dime in Stocks, Bonds, or Real Estate…”
In other words, it may look like there are few sellers. But in reality, those sell orders are being diverted to a dark pool that none of us can see.
How Hedge Funds Can Exploit Options
One user on Reddit has an interesting theory as to what’s causing the downside move in meme stocks, and I think they might be onto something.
According to u/GMoney-KS, hedge funds are finding new and creative ways to take advantage of the tsunami of options contracts traded daily on meme stocks:
“Hedgies [are] buying deep in the money puts … layering them and creating gamma ramps downward so that options market makers keep having to naked short (see short exempt volume) in order to stay delta neutral on sales of naked puts. As the price drops, more puts keep going in the money … and calls are going out of the money … creating a ‘double’ sell impact as options market makers who have delta hedged for calls can now sell shares they no longer need for calls that were previously in the money.”
Let me translate that into English (for anyone who isn’t an options trading genius yet)…
The mechanic that u/GMoney-KS described is a very real one. It has to do with market makers’ requirement to stay delta neutral (or to not be skewed too far to one side of an options chain).
If big money hedge funds keep buying ITM puts, the market makers have no choice but to short common shares of the underlying stock in an attempt to hedge the puts they sold.
This causes a “double whammy” effect. The downward price pressure comes from two places simultaneously — put-buying from hedge funds and common-share shorting by market makers.
While this is impossible to determine for certain, this Reddit user might have the right idea. If hedge funds are pressuring market makers in this way, that could explain why AMC and GME have shed so much value in such a short period.
As a final note, we must brush up on the role of market makers in options trading…
A Note About Market Makers
Every options trade is a transaction between two parties.
When you buy an options contract, there’s a market maker (MM) on the other side of the trade who’s gaining money by selling it to you.
MMs are individuals (or entities) who professionally buy and sell options contracts, looking to profit off of the bid-ask spread.
These guys aren’t like you or me — trying to book 100%+ gains on weekly options. Instead, they focus on selling contracts with size and volume. The more you trade, the more they make.
If market makers trade a disciplined strategy with consistency, they can potentially make boatloads of cash without taking on as much risk as an options trader.
In my opinion, the GME and AMC short squeezes changed the options market forever.
There’s never been this much volume or liquidity on calls, and puts and market-making is a bigger game than it’s ever been.
Let’s be honest — AMC and GME have been fundamentally overvalued since their epic short squeezes took place. The reason for the recent selling could be as simple as the charts coming back to Earth.
And let’s not discount classic December tax-loss harvesting or an extremely weak overall stock market as possible causes.
Ultimately, stocks are unpredictable. And meme stocks? Even more so.
Don’t trust everything you read on social media. Many of these “traders” have no clue what they’re talking about.
This information wasn’t difficult to find. I simply did some research and due diligence.
The lesson? Do your homework. Filter out the noise. And pay attention to the details in the options market.