Lesson 17 of 25 · 7 min
A single retail-heavy share, January 2021: the margin episode
The collateral requirement on a short rises with the same move that creates the loss, and covering pushes the price further.
In January 2021 the shares of GameStop, a retailer of video games, rose from a level reported at around seventeen to twenty dollars in the middle of the month to an intraday high reported at about four hundred and eighty-three dollars on 28 January 2021. Short interest beforehand was reported at more than one hundred percent of the free float, which is possible because a borrowed share can be sold and borrowed again.
Three mechanical buyers operated at once, and none of them was expressing a view. Short sellers facing rising collateral requirements had to buy to close. Options dealers who had sold call options had to buy shares as those options moved toward the money, because their hedge ratio rises with the price. And the cost to borrow the shares rose sharply, adding a carrying cost to holding the short at all.
The collateral arithmetic is the part worth internalising. A short position's requirement is a percentage of its current market value, so a price that triples triples the requirement while simultaneously producing the loss that consumed the equity. Brokers also raised requirements on the specific names toward one hundred percent of value, which is a discretionary change of the kind Track 8 lesson 15 describes.
The episode is often told as a contest between groups of people. The mechanism does not need any of that. A crowded short position in a small float, a rising price, and a requirement indexed to that price produce forced buying whoever is on either end.
Key terms
- Short interest
- Shares sold short but not yet repurchased, often quoted against free float. It can exceed the float because a borrowed share can be re-lent.
- Cost to borrow
- The fee paid to borrow shares in order to hold them short. It rises when shares are scarce, adding a running cost to a losing position.
- Hedge ratio
- The number of shares a dealer must hold to offset an option position. It rises as the price rises, forcing purchases into a rally.
Worked example
How the requirement tracks the price
Illustrative figures scaled down so the arithmetic is followable; they are not the reported amounts. A short of 1,800 shares at $34.60 with cash posted equal to 50 percent of proceeds, when the price reaches $148.20 and the broker raises the requirement to 100 percent of value.
- Proceeds of the short sale
- $62,280
- Cash posted at the outset
- $31,140
- Cost to close at $148.20
- $266,760
- Loss on the position
- $204,480
- Requirement at 100 percent of value
- $266,760
- Shares that must be bought to close
- 1,800
1,800 × $34.60.
50 percent of proceeds.
1,800 × $148.20.
1,800 × ($148.20 − $34.60).
8.57 times the cash originally posted.
The cure is a purchase of the rising share.
The loss was 6.6 times the posted cash and the requirement was 8.6 times it. Both grew with the price, and so did the size of the purchase needed to stop them.
Check yourself
A short position of 400 shares opened at $22.50 faces a price of $96.00, with the requirement raised from 50 percent to 100 percent of market value. How much collateral is now required, against how much at the start?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.