Hedge Fund Torched By AMC

On glamorous Madison Avenue in midtown Manhattan, as most people were heading home for the day, the top executives of a powerful hedge fund filed into a conference room. The fate of this multibillion dollar institution could be at stake.

This is Mudrick Capital Mangement, L.P. With offices in New York City and London, it manages approximately $3.8 billion. Or did, until a struggling theater operator’s stock started to climb, seemingly out of nowhere:

Inside Mudrick, executives were growing apprehensive as the AMC rally gained steam. The firm’s risk committee met on the evening of June 1 after the stock closed at $32 and decided to exit all debt and derivative positions the following day.

It was a day too late.

AMC’s stock price blew past $40 in a matter of hours June 2, hitting an intraday high of $72.62. Call option prices soared amid a frenzy of trading that Mudrick Capital contributed to and, by the end of the week, the winning trade had turned into a bust, costing the fund hundreds of millions of dollars in losses.

Mudrick lost about 10% of its value, or around $400 million, in just a few days. These losses came not from short sales but from selling call options, or a right to purchase the stock at a specific price. The options Mudrick sold gave the buyer the right to buy AMC at $40 a share. At the time, it seemed inconceivable the stock could ever go that high.

Inconceivable except to retail traders on Reddit, among other forums. They pushed the stock to all-time highs, badly bruising Mudrick.

Mudrick sold these options to hedge the risk they took in lending AMC money. I think it would’ve been a lot smarter to buy credit default swaps, which are like insurance. If the company in question goes bankrupt, the seller of the swap has to pay you. But, buying the swaps costs money up front, whereas selling the calls produced income right away. Mudrick seems to prefer the quick buck to long-term risk management.

I find the sight of powerful hedge funds being torched by average Joes quite amusing. If other funds don’t want to join them, I’d suggest treating all meme stocks with extreme caution.

More on AMC:

Photo: “Police Stationed outside AMC Theater showing Joker film 4573” by Brechtbug is licensed under CC BY-NC-ND 2.0

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