Meme stock meltdowns: New Single-Stock Inverse GME/AMC ETFs

The U.S. Securities & Exchange Commission's (SEC) recent approval of single-stock ETFs clearly opened the floodgates for a slew of novel funds to debut. Previously, leveraged / inverse ETFs in the U.S. market were limited to tracking broad indices, sectors, or themes comprising baskets of numerous stocks, bonds, or commodities futures.

Not anymore. Investors who want to go long or short a single stock, say Tesla (TSLA) with leverage can look to providers like AXS Investments and Direxion, who have debuted leveraged and inverse single-stock ETFs tracking dozens of popular, highly traded companies. 

Naturally, the emergence of a single-stock ETF tracking meme stocks was inevitable. Recently, Rex Shares filed prospectuses for multiple inverse single stock ETFs. Notably, some of them will track well-known meme stocks, like Gamestop (GME) and AMC Entertainment (AMC). 

Both financial media and retail investors are in an uproar about these products. CNN hailed them as "the next sign of the market apocalypse," while numerous self-proclaimed Reddit "Ape" investors think it’s a conspiracy to short their beloved stocks into the ground. 

In my opinion, they're both wrong. I think single-stock ETFs, especially those tracking meme stocks can be a powerful tool for retail investors. From my point of view, their use prevents many of the usual risks that blow up accounts – misusing options, margin calls, etc. Let's get into it. 

A brief history of meme stocks

The whole meme stock craze started back in late 2020 when a Reddit investor (and Chartered Financial Analyst, or CFA) named Keith Gill (username "DeepF*ckingValue") began posting his GME due diligence ("DD") on the popular r/WallStreetBets subreddit.

In his DD, Gill essentially argued that GME was trading in deep-value territory. Other investors soon found that GME had been excessively shorted. From there, a movement began to buy shares of GME to "squeeze" the hedge funds that held short positions. 

It worked to an extent, with Melvin Capital incurring heavy losses and eventually folding. The share price of GME eventually hit above $400 before plummeting after brokerage app Robinhood "turned off the buy button," landing themselves a congressional committee inquiry. 

This roller-coaster cycle has repeated multiple times, with the share price of GME soaring and cratering over and over. A very ardent (some would say "cult-like") community has formed around GME. This community (which has since fractured into numerous subreddits reminiscent of a religious schism) has since hyped-up multiple catalysts they believe will bring about the "mother of all short squeezes" (or "MOASS"). Notable recent ones (which all turned out to be nothingburgers) include:

• The debut of the GME NFT marketplace, which hosted an NFT based on a 9/11 victim in its first week and sold stolen NFT games without the creator's consent.
• GME's 4-1 forward stock split in July, which Apes were clearly unpleased about due to the lack of positive price action occurring thereafter and took to harassing their brokers about whether or not it was executed correctly. 

Beyond GME, AMC and now Bed, Bath, and Beyond (BBBY) were also elevated to meme stock status. The former rode the coattails of GME during the January 2020 squeeze, with CEO Adam Aron recently releasing a preferred equity unit called "APE" to raise more capital. 

BBBY on the other hand took off in summer 2022 after GME Chairman Ryan Cohen disclosed a stake in the company, including numerous out-of-the-money (OTM) call options. After this, a buying frenzy commenced, with the price of BBBY soaring from $5 per share to $23 per share by August 17th.

Cohen then sold the entirety of his stake, dumping the share price by 40%, with many accusing him of "rug pulling" Apes. Since then, BBBY has continually tanked on poor news, including:

• A "turnaround plan" that involved closing approximately 150 stores and cutting 20% of its corporate and supply chain staff, while raising $500 million in additional financing.
• The tragic September 2nd suicide of their Chief Financial Officer, Gustavo Arnal.

Betting against meme stocks

The demise of Melvin Capital should serve as a sober warning for any retail investors endeavoring to go short on meme stocks. Simply put, the risk-reward profile is far too skewed. Although the underlying companies have poor fundamentals, their share prices are capable of volatile, unpredictable pumps. 

In other words: "meme stock prices can stay irrational longer than you can stay solvent." 

Selling short a meme stock exposes an investor to the prospect of unlimited losses. In addition, interest rates for borrowing shares currently runs very high, partially thanks to a campaign by meme stock investors to "direct register" (DRS) their shares to prevent securities lending. 

Investors can short meme stocks and manage risk better by using buying put options. With puts, your capital at risk is limited to the premium paid. However, thanks to the high implied volatility (IV) of the underlying, put options for meme stocks are priced expensively. You'll also have to contend with selecting the right strike price, expiry date, worry about theta, IV crush, etc.

Inverse ETFs solve most of these issues. Investors who buy a single-stock inverse ETF can only lose what they put in. There's no risk of margin calls here or interest payments like selling a stock short. With single-stock inverse ETFs, an investor's only need to predict the stock's direction correctly to profit, unlike options where IV and options Greeks need to be factored in.

The usual issues with holding leveraged and inverse ETFs for periods longer than a day apply here. These ETFs usually use over-the-counter swap derivatives with a counterparty to obtain daily resetting exposure to the underlying returns. The daily resetting leverage can cause long-term returns to vary wildly from the intended target due to compounding and volatility decay. It’s not unusual to see inverse ETFs decay in share price and go through numerous reverse splits. 

As with all complex investment products, caveat emptor. 

Please note this article is for information purposes only and does not constitute investment advice.