Source: https://www.thestreet.com/memestocks/gme/has-gamestop-stock-been-targeted-by-synthetic-short-positions

Some in the retail investing community have claimed that GameStop's stock has been adversely affected by synthetic short positions, with banks using total return swaps to create synthetic short exposures.

The 2021 Archegos Capital Managementย?scandal is one recent and prominent case involving the misuse of total return swaps; ACMโ€™s family office used highly leveraged positions and risky trading strategies.

While the Archegos scandal and the GameStop short squeeze are separate events, they both shed light on the potential risks associated with derivatives trading and the need for greater transparency in capital market structures.

Was GameStop stockโ€™s performance affected by synthetic shorts?

GameStop's socially-mobilized investors have long argued against the opacity in capital market structures.

The theory that GameStop shares have been affected by synthetic positions is widely echoed within the "ape" community, and the drumbeat has become louder amid recent failures among financial institutions (such as Credit Suisse, which is itself strongly linked to the scaling of the Archegos debacle).

In the case of GameStop, when banks engage in short positions using swaps, they typically use other financial institutions, hedge funds, or sophisticated investors as counterparties. These counterparties agree to take the opposite side of the trade and assume the long position in the swap. By initiating a swap, then, banks can effectively create a synthetic short position.

This strategy is valid when a financial institution decides to take a short position in a specific asset - such as a stock - but does not want to take ownership of a counter asset and cannot easily take a short position on the open market. The bank or other financial institution looking to create a short position via swap enters into a swap agreement with a counterparty and typically agrees to pay a notional, floating interest rate.

The counterparty agrees to pay the bank the return on the asset it is willing to short. If the asset value the counterparty wants to short decreases, the bank pays the counterparty a difference, essentially replicating the profit gained from a short position.

By using swaps, banks can create short exposure to various assets without actually holding or selling those assets. This approach offers flexibility and liquidity, which can be especially beneficial when shorting assets with limited availability or regulatory restrictions.

It is worth mentioning that the use of swaps for short positions is generally legal in the United States, subject to compliance with relevant regulations and laws. Swaps are in fact widely-used financial instruments, and their use for both hedging and speculative purposes is common in the U.S. financial markets.

The Archegos Capital Management scandal

A scandal involving Archegos Capital Management was one of the most notorious recent cases involving the misuse of total return swaps.

Archegos was a family office run by investor Bill Hwang, and it used a highly-leveraged and risky trading strategy to build prominent positions in several companies' stocks, primarily through total return swaps and other derivatives. The family office was involved in a significant financial scandal in March of 2021.

Using borrowed money from banks to amplify its investments, Archegos took highly concentrated positions in a few stocks. The firm's leverage was estimated to be extremely high, sometimes exceeding 5-to-1, which meant it was borrowing five dollars for every dollar of its own capital.

Total return swaps allowed Archegos to gain exposure to underlying stocks without being required to disclose its holdings publicly - unlike with traditional stock ownership.

As the stock prices of some of the companies Archegos held started to decline, however, the value of its positions fell sharply. This, in turn, triggered margin calls from the banks that had provided it with leverage. When Archegos failed to meet these margin calls, the banks began liquidating their positions to limit their exposure to potential losses.

The forced liquidation of Archegos' massive positions in various stocks significantly impacted the market, leading to sharp declines in those stocks' prices and causing losses for the involved banks.

Several large global investment banks, including Credit Suisse and Nomura, were among those that suffered significant losses due to their exposure to Archegos' trades.

How does this relate back to GameStop's short squeeze?

At first glance, Archegos Capital Managementโ€™s scandal and GameStopโ€™s short squeeze may seem totally unrelated.

The GameStop short squeeze involved a group of retail investors organizing on online forums, such as Reddit's WallStreetBets, to drive up the price of GameStop's shares. They targeted heavily shorted stocks, including GameStop, causing a rapid surge in the stock's price. This resulted in substantial losses for some hedge funds and other institutional investors that had taken short positions in GameStop.

On the other hand, Archegos Capital Management was involved in an incident of its own devising that just happened to unfold around the same time as GameStopโ€™s first massive squeeze.

However, ACMโ€™s scandal highlights risks associated with highly-leveraged trading strategies and total return swaps.

And over the past several years, financial institutions such as hedge funds have used total return swaps, provided by banks, to short meme stocks baskets, effectively distorting these assetsโ€™ short interest.

GameStop and other meme stocks, such as AMC, have had a high correlation with each other in recent years, indicating their tickers may be related to each by dint of being included in the same portfolio swaps.

Interestingly, just two months before Archegosโ€™ collapse, in January 2021, ACMโ€™s court-submitted swaps showed gigantic movements being made against just a few counterparties.

Following these significant events in 2021, the SEC has been scrutinizing the transparency of trading structures and advocating for greater disclosure of short-selling, increased transparency around securities lending, and new reporting rules for the "total return" equity swaps that felled Archegos.

• TheStreet is pulling at the Archegos swaps scandal, highlighting risks associated with highly-leveraged trading strategies and total return swaps.

• Looks like they visit the sub?!?! https://www.reddit.com/r/Superstonk/comments/15gfu4z/archegos_swaps_submitted_to_court_with_big/