AMC's (NYSE: AMC) Price Doubles in a Day: Is the AMC Short Squeeze Happening?
On Wednesday (2 Jun 2021), American movie theatre chain AMC Entertainment Holdings Inc. (NYSE: AMC)’s share price more than doubled from US$32.04 to US$68 after hours.
Also, other so-called ‘meme stocks’ surged after hours on Wednesday as well:
- Bed Bath & Beyond Inc. (NASDAQ: BBBY) went up by 60.5%.
- Koss Corporation (NASDAQ: KOSS) went up by 65.6%.
- BlackBerry Ltd. (NYSE: BB) went up by 35%.
- GameStop Corp. (NYSE: GME) went up by 13.3%.
This rally can be considered a continuation of the Reddit fueled meme stock rallies that occurred in January and March this year.
Yet again, dedicated individual investors have banded together on social media platforms like Reddit and Twitter to drive the stocks higher.
This may have led to today’s wild trading session where AMC’s stock price soared so quickly that four trading halts were triggered during this trading session.
When trading closed on Wednesday, more than 710 million shares changed hands. This is almost two times the amount of AMC’s outstanding shares. Not to mention that the company’s 30-day average traded volume is 143 million shares.
This recent spike has seen AMC’s share price soar ~2,850% year to date, exceeding GameStop’s ~1,400% gain.
You may be wondering, what’s behind this recent rally?
Here is what you need to know!
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock. The writer may have a vested interest in the companies mentioned.
TL;DR: AMC Short Squeeze?
- AMC’s price is detached from its fundamentals.
- AMC’s recent price rally is likely to have been caused by a gamma squeeze.
- This might trigger a short squeeze.
- But ultimately, this is still a very risky and speculative play that might go wrong for people holding AMC stock.
AMC’s Price is Detached From Fundamentals
In an interview with Yahoo Finance, Wedbush Securities (an American wealth management firm with about US$2.4B billion under management and about 6,000 clients) equities research analyst Alicia Reese had this to say about AMC’s recent rally:
Well, it’s not based on fundamentals. So it’s not something we can predict as closely as we have been able to predict it in the past.
Looking at the fundamentals, it would normally trade between 7 and 9 times 23 consensus EBITDA.
Right now, it closed at 43, 44 times that.
The enterprise value has more than doubled since yesterday. And that was extremely high, compared to where it’s normally trading. So we have a pretty big disparity. When that comes down or whether that stays up or continues to rise is your guess is as good as ours.
FYI: EBITDA = Net profit + Interest + Tax + Depreciation/Amortisation expense. It is a measure of profit after tax which is the net income or net earnings. i.e. income minus all expenses and taxes. It is the actual profit that the owners of a company can pocket.
Wedbush has set a US$6.50 price target for AMC which ‘takes into account pretty aggressive industry box office, domestic industry box office results, as well as in Europe. And we put a pre-COVID peak multiple of 9 times our 23 estimates.’
This price target marks a -91% downside to AMC’s current stock price of US$68.
One thing is clear from AMC’s recent rally.
AMC’s stock price is detached from its fundamentals as it is currently trading significantly higher than what Wedbush values it at.
Other analysts are less bullish.
The median price target of seven analysts covering AMC have a 12-month median price target of US$3.70 for AMC.
But, it seems like AMC will continue to rally. However, you can expect significant price volatility.
Wedbush also mentioned that it does not expect AMC to return to ‘our price target in the near term. But we do think it eventually will.’
At this point in time, it is clear that AMC’s stock is way overvalued.
In other words, the price movement we are seeing with AMC is driven by speculation and not related to its fundamentals.
So you might be thinking, what exactly is behind AMC’s recent rally in price?
What is Behind AMC’s Rally? Is an AMC Gamma Squeeze Happening?
In my opinion, AMC’s recent price rally could be attributed to AMC’s option volume and a possible gamma squeeze.
FYI: A call option is a contract whereby the buyer has the right to buy 100 shares of a stock within a specified time period (up to the expiry date) at a pre-agreed price (strike price).
Instead of buying the stocks, you are paying a premium for the contract that grants you the right to buy the stocks later.
These contracts are written by entities called market makers (MM).
Basically, an MM is there to provide liquidity for the stock market as a wholesale buyer and seller of securities. MMs are always ready to sell to buyers (at the ask price) and to buy from sellers (at the bid price) they have quoted.
As such, the quoted prices from the MMs are an indicator of market supply and demand.
In return, they pocket the profit from bid/ask spreads: the amount by which the ask (selling) price exceeds the bid (buying) price of a security.
When it comes to options, these MMs are the entities that provide contracts for people to buy options.
Now let’s look at the AMC’s option data for options that are expiring tomorrow (4 Jun 2021).
This option activity indicates that a gamma squeeze is happening.
At the time of writing 377,745 call options are in the money. This means that the MMs will have to purchase 37.7 million shares to fulfil these call option contracts that are expiring tomorrow.
FYI: A call option is in the money when the market price is higher than the option’s strike price.
A gamma squeeze is what occurs when many short-dated call options for a stock are bought up.
This can effectively create an upward domino effect where the buying of these call options will drive the stock price higher. This then leads to more call options being bought and the stock prices being driven up further.
Now that we’ve hit this point, the price has gone up quite a bit.
On Wednesday alone, AMC’s price went up by 112%!
That is bad news for the people shorting AMC as they bought AMC stocks in hopes that the price will drop so they can buy the share back at a cheaper price.
With AMC’s price being driven up by the Gamma squeeze, the shorts will eventually be forced to close out of their short position, which requires them to buy more AMC shares and drive the price up even further!
This is what brought GME to its peak of US$472 per share in January 2021.
But a word of caution, gamma squeezes are more often than not a double-edged sword.
Just as they can drive buying pressure, they can drive selling pressure as well.
As the price of a stock falls, gamma will start to fade and drive the price down.
But for now, it appears AMC’s price is going up because of gamma squeezes. This might trigger a short squeeze.
AMC Short Squeeze?
Before we talk about short squeezes, here is a recap of what short squeezes are from the GME article we wrote.
A short squeeze happens when a stock’s price unexpectedly rises at a rapid rate.
Investors who hold a short position in the stock are ‘squeezed’ as they have to cover their positions and buy up more of the stocks.
This in turn increases the stock’s price even further. Subsequently, this may even trigger additional margin calls and short covering for investors shorting the stock, further driving up the price in a brutal feedback loop.
Also, when the short are scrambling to cover their positions, the huge surge in price may attract new speculators to buy up the stock to make a quick profit.
This in turn lowers the supply and increases the demand for the stock.
As the many institutional investors who are betting against GameStop would attest, shorting is infinitely risky.
Financial analytics company S3 Partners estimates that AMC shorts suffered mark-to-market losses of about US$2.29 billion on AMC in 2021.
For the uninitiated, here is an explanation of the stock shorting process.
The first step would be to borrow stocks from a broker as you are betting that the price of the stock will go down,
Let’s say you borrowed 100 stocks of a company from a broker with a price of $1. It is important to note that you are not spending any money as you are just borrowing the stocks.
Do note that when shorting, you are required to return the borrowed stocks to the broker on a date set by the broker.
Next, you go and sell the shares to somebody and get $100 for your efforts.
Instead of returning $100 to the broker for lending the shares, you wait for the share price to drop to let’s say $0.50 cents a share. This enables you to buy the 100 shares for just $50 to return to your broker.
As a result, you have just made $50 in profit for shorting the stock.
Not so fast.
It is important to note that although shorting a stock can provide gains, your losses are potentially infinite.
If you are shorting a stock and its price goes up beyond 100%, you could potentially lose 100% of the capital you put in to buy the stock and more.
For example, let’s say the stock price for the company you shorted went up by 200% to $2 a stock. You end up losing all your initial capital ($100) and an additional $100 as you have to buy the stocks back at the increased price to return to the broker.
This is because you are required to return your shorted stocks to the broker at a set time and are forced to buy the stocks at whatever price you could get them to return to the broker.
As such, your losses are potentially unlimited if you do not close your position as the price of the stock you short can continue going up, deepening your losses.
If you do not have enough in your account to cover this loss and falls under maintenance, brokers will invoke a margin call and force you to buy more stocks to cover your short position.
Also, if you hold a huge short position, there may not be enough traded stocks to quickly exit your position.
This can result in the above mentioned short squeeze.
Not to mention that you have to pay interest for borrowing the stock.
The worse part?
Shorting stocks might not be a good investment even if it ‘pays’ off as some stocks take years to fall in price. This means that you will only get a tiny annualised return over the years.
AMC Short Interest
According to S3 Partners a financial data, analytics and services firm, the short interest for AMC stands at U$2.36 billion.
About 90.52 million shares out of 417.68 million shares in AMC’s stock float is being shorted.
In other words, 20.19% of the company’s shares are being shorted.
Also in 2021, shorts suffered mark-to-market losses of about US$2.29 billion on AMC.
AMC Short Squeeze Thesis
As AMC is being shorted heavily, the shorts might be in trouble as they will have to eventually close, or cover their short position.
Also, AMC’s price has gone up exponentially which is bleeding the shorts dry. Generally, the higher AMC’s price goes, the more losses short will incur.
Not to mention that the holders of AMC stocks are not obligated or might not be willing to sell their AMC shares (#diamondhands). This may result in a crisis of supply and demand.
This low supply and high demand may cause the price to soar. In theory, there is no limit to how high the price the stock can go as the shorts have to cover.
Even if the shorts get margin called and default, their lender will have to pay the leftover debt.
How This Might Go Wrong
Ultimately, AMC’s short squeeze thesis and narrative may not come to fruition and is not guaranteed to work.
In the case of bad news, or a large sell-off this can cause the price of AMC to eventually fall back to the US$6.50 price target based on fundamentals.
This might cause the gamma squeeze from happening which means that the short squeeze might not happen as well.
Another point to keep in mind is we don’t know exactly when the shorts will have to cover.
The shorts can simply dig deep and wait for AMC holders to give up and sell their shares.
But if the gamma squeeze continues and the holders of AMC have diamond hands and do not sell their shares the shorts will have to close.
Also, holding these short positions is costing the hedge funds.
According to IBorrowDesk (tool for monitoring stock borrowing rates and availability using data from Interactive Brokers); short holders currently have to pay interest on the borrowed stocks at a rate of 11.3% per annum.
But, this fee can increase and it has recently surged as AMC’s price continues to climb.
Ultimately, this is still a very speculative and risky play as you could lose almost all your capital investing in AMC as there is no telling how this situation might play out.
In these types of events, you should not be putting in money you cannot afford to lose.