Pass the Popcorn!

Here is the latest from Daniel Frampton APFS about the AMC chain of cinemas. Read on to find out more.

“3,000% returns in 6 months – all because of a broken and outdated system. That is the best way to describe the rollercoaster ride that AMC investors have experienced recently.

AMC is a chain of cinemas based in America and listed on the New York Stock Exchange. It was highly leveraged, debt laden and unable to generate any revenue, thanks to nationwide lockdowns – anyone would think that AMC would fold under the immense pressure and become insolvent.

Hedge funds thought exactly that, and they decided to “short” the company. In effect this is the opposite to traditional investing as you benefit if the share price falls. The original idea was that you could sell your own shares and then buy them back later at (hopefully) a lower price – your profit/loss would be the difference between your sale and repurchase price.

Rather dangerously it is possible to do what’s called a “naked short” – this is when you short a stock you don’t own. Fundamentally, you take out a naked short position via the following process:

– Investor A borrows £1,000 from their broker.

– Their broker uses the borrowed money to buy AMC shares and immediately sells them back into the markets at the same/similar price.

– Investor A’s £1,000 position is now open.

– The only way of closing the trade is by repurchasing the shares – whatever their price.

– If the share price rises to the equivalent of £1,100 and Investor A wants to close their trade, they have to give back the original £1,000 plus an additional £100 to repurchase the shares.

– If the share price falls to the equivalent of £900 and Investor A wants to close their trade, they can repurchase the shares for £900 and keep the £100 left over as profit.

– They cannot just settle the trade in cash – they HAVE to repurchase the shares.

If the above scenario occurred and the shares, were later valued at £2,500, the investor would have to pay the market value to close the trade. This counts as buying the shares and actually pushes the price up.

Analysts realised that AMC was shorted to 140% of its market capitalisation. This meant more people had short positions than investors with long positions, ie traditional investors holding shares. This situation triggers a market event called a “short squeeze” and it’s potentially the most expensive staring contest ever.

Investors realised that the more they pushed the price up, the more people would want to close their short positions which would effectively push the price up even further. This snowballs very quickly.

AMC was sitting at around $2 a share in January 2021 yet on 2nd June it closed at $65 a share – an increase of over 3,000%. All of which was caused by greedy hedge funds trying to profit off a struggling company.

A staring contest to end all staring contests.”

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