Reddit Forum Shows Its Power over Stock Prices

The first sign of trouble for hedge fund wunderkind Gabe Plotkin came in late October: A poster on Reddit’s popular “wallstreetbets,” or “WSB,” forum was taking aim at his wildly successful investment firm.

“GME Squeeze and the demise of Melvin Capital,” wrote the user, Stonksflyingup, referring to GameStop Corp. (stock ticker: GME) and Plotkin’s $12.5 billion firm. Before long, veryforestgreen weighed in: “Melvin Capital New Short Attack.” Then, greekgod1990: “Melvin vs WSB! And GME to the moon.”

So it was that the tables turned on Wall Street—and a hedge fund star suddenly found himself at the mercy of the day-trading Reddit bros who have become one of the most powerful, if improbable, forces in the stock market today. The attack on Plotkin’s six-year-old Melvin Capital shifted the balance of power in ways that would have seemed unimaginable only months ago. By Wednesday, the firm had capitulated to the amateurs and covered its GameStop short.

The explosive growth in retail day-trading, powered by platforms like the Robinhood trading app and forums like wallstreetbets, has turned the old order on its head. Melvin Capital’s mistake, if it can be called that, was leaving footprints behind in the marketplace. Reddit users were able to identify stocks that Melvin was wagering against and then buy those en masse, unleashing a violent run-up in prices that turned Melvin’s winning bet into a loser.

Melvin’s losses mounted in January, and after they passed 15 percent last week, the firm had conversations with investors and got commitments of about $1 billion for February 1. By the end of last week, losses had mounted to about 30 percent. On Monday, Plotkin turned to billionaire hedge fund founders Ken Griffin and Steve Cohen (Plotkin’s former boss) to shore up the firm.

Melvin’s cash infusion was almost unheard of in hedge fund land. Griffin, his partners, and the hedge funds he runs at Citadel threw in $2 billion. Cohen’s Point72 Capital Management, which already had about $1 billion invested in Melvin, ponied up another $750 million to help put the firm back on the offensive.

That Cohen would step in made sense, given his longstanding relationship with Plotkin—and he could be seen as bailing out his own investment. For Griffin, it was a rare opportunity to invest in a talented manager on the cheap. Both firms got a minority revenue share from the firm for stepping in.

Griffin, who started Citadel in 1990, has a history of swooping in when others are in distress. He’s hired teams or took on assets from hedge funds such as Sowood Capital Management, Visium Asset Management and Amaranth Advisors after they imploded. He may also have welcomed the chance to invest in Plotkin’s fund. Melvin generally manages money for charitable organizations like endowments and foundations.

Late Tuesday, Cohen broke his usual habit of tweeting only about his New York Mets. “Hey stock jockeys keep bringing it,” he wrote on the social media platform.

Rough crowd on Twitter tonight. Hey stock jockeys keep bringing it — Steven Cohen (@StevenACohen2) January 27, 2021

Day Traders Flex Their Muscles

As of Tuesday, Melvin’s losses had increased even with the portfolio repositioning, though investors wouldn’t say by exactly how much for fear of angering the money manager, which they expect can still fight its way back.

A representative for the firm declined to comment on performance, other than saying the portfolio had been repositioned in the past few days and “the social media posts about Melvin Capital going bankrupt are categorically false. Melvin Capital is focused on generating high-quality, risk-adjusted returns for our investors, and we are appreciative of their support.”

The risk of going long is intuitive: Buy $50 of shares, and if the price drops, you lose that amount. But it may be less obvious that losses on bearish bets can be more severe and swift. A classic $50 short can lose multiples of that amount if the stock soars. And while using options may limit losses, investors can get wiped out quickly if the stock rises.

Investors caught in a short squeeze can close out bets and eat their losses, or try to ride out the price surge—typically requiring they put up more money. The shorts that were listed in Melvin’s regulatory filing from the third quarter all rocketed in recent weeks. Names include Bed Bath & Beyond Inc., iRobot Corp., and GSX Techedu Inc. GameStop, the stock that seemed to set off the short squeeze, soared 634 percent in the month through Tuesday, and an additional 31 percent in post-market trading after Elon Musk tweeted a link to the Reddit thread with the caption “Gamestonk!!”

Gamestonk!! https://t.co/RZtkDzAewJ — Elon Musk (@elonmusk) January 26, 2021

Until this year, Plotkin, 42, had one of the best track records among hedge fund stock pickers. He’d worked for Cohen for eight years and had been one of his biggest money makers before leaving to form Melvin—named after his grandfather—in December 2014.

So good was Plotkin’s reputation that the firm closed to additional investors before word had even spread that he was setting out on his own. Despite a loss in 2018, he’s posted an annualized return of 30 percent since opening, ending last year up more than 50 percent, according to an investor.

Then came January, when Melvin first became aware that a Reddit crowd had put a target on the firm’s positions, ramping up an attack on GameStop and other shorts.

A New Kind of Portfolio Risk

Why they singled out Melvin remains a mystery. As far as hedge fund managers go, Plotkin is considered low-key. He doesn’t show up at many conferences or hobnob at society balls. Former colleagues and current investors say he’s a nice, quiet guy—not the type to make enemies.

The most obvious explanation is that his positions were knowable. Hedge funds generally go to great lengths to guard their short positions. If they use put options, for example, they buy them over the counter, which means they don’t have to list them in regulatory filings. Plotkin’s filing in the third quarter showed put options on 17 companies, many of them highly shorted names.

“There’s no targeting going on—WSB is far less organized than all the articles are making it out to be,” said Lucas Severyn, a member of wallstreetbets. “From time to time, WSB gets obsessed with some stock. Now it’s GME, and for the first time ever, this stock just keeps giving.”

Investors have been expressing faith that Plotkin will climb out of this hole. Griffin said Monday that he and his partners “have great confidence in Gabe and his team.” Cohen called him “an exceptional investor and leader.”

A person familiar with the thinking inside Plotkin’s firm said one lesson is clear: Don’t leave a trace, and only buy put options over the counter. “This phenomenon of retail investors jumping on a bandwagon to dominate trading activity is a new kind of portfolio risk,” said Jay Raffaldini, global head of sales and distribution at UBS O’Connor. “It’s going to cause a lot of hedge funds to rethink how they approach their long and short investment strategies.”

—With assistance from Sarah Ponczek, Spencer Norris & Misyrlena Egkolfopoulou.

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