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'Is it Money You Can Lose?' FAU Professor On GameStop, Reddit And The Stock Market

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In an ongoing fight between amateur investors and Wall Street hedge funds, hedge funds got the upper hand this week. Florida Atlantic University professor Rainford Knight explains the stock market drama connecting Reddit users, institutional investors — and potentially Congress.

In an ongoing fight between thousands of amateur investors and large Wall Street hedge funds, hedge funds started to get the upper hand this week. Thousands of users on a subgroup — also known as a subreddit — of the online forum Reddit have been investing money into stocks like GameStop and AMC Entertainment in a coordinated effort.

Meanwhile, institutional investors are betting against the success of these stocks through a process known as short selling.

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As GameStop and AMC are hemorrhaging value in the stock market, politicians across the political spectrum from New York U.S. Rep. Alexandria Ocasio-Cortez to Texas Sen. Ted Cruz have called for greater regulation in the stock market.

One sticking point for lawmakers and retail investors alike has been the actions taken by free investing platforms like Robinhood. The platform is used by many of the amateur traders buying these stocks and last week it limited the number of shares users could buy.

"You have to put up capital to put up trades. They had to raise two or three billion dollars and so they had to limit the amount of trades users could have," said Rainford Knight, a finance professor at Florida Atlantic University, on WLRN Sundial.

Knight spoke with Sundial senior producer Chris Remington about the implications the ongoing saga could have on future regulation on the market. Below is an excerpt from the conversation.

WLRN: Rainford, I'm going to go back in time a little bit back to fall of 2008, I was a senior in high school, taking an introduction to economics class. And my teacher, a former Wall Street investor himself, he threw the textbook out in October. Lehman Brothers had just crashed and the Great Recession was upon us. And he said, "We're going to learn about this crash, while it's happening." I'm curious for you as a professor, how are you teaching about this moment and what's happening in the stock market right now?

KNIGHT: Yeah, that's a good question, Chris. In the classroom, we typically typically teach that, when you look at markets, it's dominated by the big institutions on the trading side. And so the retail investor is at a significant disadvantage. I think this event with GameStop, rather, has really shed light on on the power the retail investor can have when they get together and publicly display. And this is where the SEC [Securities and Exchange Commission] is having a problem. When they [retail investors] publicly say they're going to be moving in on a particular stock.

And when you say retail investor, you're just talking about you and me, any average joe that wants to buy stock.

That's exactly right. The average Joe who trades on any app, Robinhood is a popular one, among others. They really want to get a piece of the action, but is at a significant disadvantage in most cases because of the big institutions and the way they trade.

We might have some [people] saying, "Wait, I don't get this. You can sell a stock before you own it?" Why don't we explain what shorting is and why it's important in keeping a check and balance in the market?

Absolutely. The stock market is the only business on the planet where you can sell something you don't own, which is short selling. And so short selling involves buying shares that you don't own and selling those shares — let's say ten bucks — with the belief that the the company's stock that you're shorting, that it's worth $2 per share and is significantly overvalued at $10. Hoping to buy the shares back at a later point, a dollar or $2 or maybe return them for a value of zero. And that's essentially what shorting is. It's kind of like buying your neighbor's car and selling it. And they're on vacation. And, you know, they can come back in two weeks. Then you're going to return the car because you can buy it cheaper at a dealer somewhere.

Do you think this is a seminal moment for the stock market and looking at the inequities that are involved in trading? You said it yourself, retail investors really don't stand a chance against a lot of these big guys. Is this an opportunity for the stock market to be rethought or is this simply a blip on the map and things will go back to normal in a couple of weeks?

I think from my perspective that the SEC really has to look at when we talk about the market, what's wrong with the the infrastructure that will allow this sort of thing to occur? What are some imperfections that exist that that we may need to be addressed? I think it's definitely a moment from a regulatory perspective where they don't have to take a really hard look at the clearing process.

Because a lot of this is is driven by how clearing of trades work and the market makers that execute these transactions. And so, if you buy 10 options and the Delta is 25, I as a market maker, I have to offset that by buying 2,500 shares. So it's akin to, every time you buy an out of the money call option, it's akin to buying shares, rather because the market maker has to hedge and they'll buy shares to offset the call. So it works the other way too on the flip side. So I think that infrastructure of the market will also have to be examined.

Chris knew he wanted to work in public radio beginning in middle school, as WHYY played in his car rides to and from school in New Jersey. He’s freelanced for All Things Considered and was a desk associate for CBS Radio News in New York City. Most recently, he was producing for Capital Public Radio’s Insight booking guests, conducting research and leading special projects at Sacramento’s NPR affiliate.