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Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult ourwebsite policyprior to making financial decisions.
If approved, a recently submitted DTCC change to how stock market actors operate could even the playing field between hedge funds and retail traders. Moreover, this could provide those trading platforms in disrepute, like Robinhood, to restore their reputation.
Lessons from the GameStop Trading Saga
In the immediate aftermath of Robinhood delisting short-squeezed stocks, it was easy to blame this solely on Robinhood’s dealings with Citadel. While this hedge fund does comprise the bulk of Robinhood’s income, and it had an invested interest in retail traders being ousted from the trading game, subsequent Congressional hearings have revealed that things are much more complicated.
From these hearings—and Keith Gill himself—we have learned that digitization of the stock market has produced unforeseen consequences. In particular, much of GME’s activity involved phantom and double shares. Because trading accounts hold stock shares as so-called digital entitlements, it was possible to short shares by 140%.
Furthermore, the same shares could have been deployed multiple times by multiple traders. Altogether, just these two artefacts of digitized and gamified trading resulted in $359 million in GME shares to fail to deliver (FTD). In his testimony for the GameStop House hearing, Gill stated that this way of doing business is the opposite to transparency.
“The ability for the same share to be shorted infinite times is a pathology. We don’t have the ability to track what shares are shorted and how many times.”
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Subsequently, as the ranking member of the Senate Banking Committee, Senator Pat Toomey (R) had proposed to shorten settlement periods to alleviate these problems. After the dust had settled, and GME hearings had concluded, new rules are in play to make retail trading a smoother and more transparent experience.
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DTCC Proposes New Rules for Trading
DTCC – Depository Trust & Clearing Corporation – is a New York-based depository of securities, founded in 1973. It is the integral cog in the stock trading infrastructure, as it keeps records of the balances of securities. Equally important, DTCC serves as a clearinghouse – the settling of trades from the moment you enter a position on the market via popular stock trading apps to the moment you exit the market.
As of April 1st (not an April Fools joke), DTC had filed a rule change to the SEC that would address the above-mentioned problems. It deals both with the multiplication of shares/securities and leveraging securities as collateral – using 40% out of 140% for borrowing or selling from the GME example.
Of note to retail traders in particular, on page 42 of the filing, you can see that the scrapping of two portions under “Pledges to the Options Clearing Corporation”.
In both instances, the change removes the return of assets to the participant’s “general free account”. As far as the dynamic between the hedge funds short selling and retail traders is concerned, these changes imply the following:
- Hedge funds would no longer be able to hide their positions by abusing call option ITM trading. Unlike futures, call options refer to financial contracts that give the buyer the right to buy assets without having the obligation. In turn, ITM – In The Money – call option happens when the underlying security’s price is above the call option’s strike price.
- Of course, with such a price differential, this gives ITM call options value, which can then be sold. When hedge funds then sell ITM call options, they mask their short positions, which appear as having been closed.
- Likewise, this would countervail synthetic put options strategy. This stock market stratagem revolves around combining long call options with short stock positions. This is done for the purpose of mimicking the long put option, or synthetic long put. In short, when synthetic shares are traded in conjunction with options, they provide an appearance of a closed short position.
Effectively, these and other proposed tweaks to the ruleset would make short-squeezing more viable in the future because opposing trading parties would not be trading in a total fog of war. In fact, just as consumer protection legislation has clauses on legalese intelligibility for contracts, the proposed rules would dissipate such fogging when it comes to retail trading. DTCC submissions are usually approved by the SEC within a week.
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About the author
Tim Fries
Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird's US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.
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