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Wall St. strategist warns on GameStop: 'There's not an infinite pool of greater fools'

AlphaOmega Advisors founder Peter Cecchini, the former chief market strategist at Cantor Fitzgerald, expects “the fantasy narrative” surrounding GameStop's (GME) surge “reverts to reality” at some point.

Cecchini, who points out that Gamestop’s “fundamentals under no circumstances justify the valuation,” believes that the retail traders who feel they're up against the hedge funds are going to be the ones “left holding the bag.”

“The only way the stock can go up in value is if you have someone that wants to buy it higher,” he said, “[Because] there's no way that there's an infinite pool of greater fools. There's not an infinite pool of greater fools. At some point, the fundamental reality of a company's performance will matter. It might not be today. It might not be this week. It might not be next month. But ultimately, it does,” Cecchini told Yahoo Finance in a phone interview on Friday afternoon.

He argues that the army of retail day traders will eventually lose interest and will turn paper profits into realized gains.

“There's not there's not an infinite pool of greater fools, meaning that at some point people are going to want to take profits and people who want to buy it at a yet higher and more ridiculous price will be left holding the bag, eventually. And that'll be exacerbated by the fact that a lot of the upward pressure on these stocks is driven by the gamma at broker-dealers. So, as soon as the option activity dies down, there’s not going to be anything supporting the bid for the stock coming from the broker-dealers.”

In addition to the fundamentals, there's a technical dynamic stemming from low-fee or no-fee options trading, creating gamma squeezes in certain stock names, something people need to pay attention to, according to Cecchini.

“One of the things that have helped to drive up the price of these names that have the short squeezes is the options activity. Retail buyers are buying these very near-dated options, which requires the broker-dealers to hedge the short calls that the broker-dealers own, and in buying the shares that helps to drive up the stock. The opposite effect happens on the way down,” he explained.

According to Cecchini, the upward pressure on these stocks is driven by the gamma by the broker-dealers, and as soon as the options activity dies down there’s not going to be anything to support the bid for the stock from the broker-dealers.

“So that'll exacerbate the fall in these stocks, especially if there are any changes to margin requirements, or the requirements and the restrictions around opening up options accounts, any of that stuff will chill the activity in these heavily shorted stocks,” he added.

A GameStop store is pictured in the Manhattan borough of New York City, New York, U.S., January 29, 2021. REUTERS/Carlo Allegri
A GameStop store is pictured in the Manhattan borough of New York City, New York, U.S., January 29, 2021. REUTERS/Carlo Allegri

Cecchini has long felt that the markets have been “somewhat dysfunctional for a while.” He highlighted monetary policy accommodation and fiscal policy coordination that's helped companies extend and amend their obligations, making folks unconcerned about default risk and thereby boosting equity valuations. What's more, fiscal policy in the form of direct deposits into personal checking accounts has found its way into the stock market, primarily via no-fee trading apps and the ability to buy fractional shares.

“Whether it's anecdotal or it's flow-based data, it's pretty clear that people are using the stimulus money to speculate in the stock market,” Cecchini added.

What’s more, Reddit users on the r/WallStreetBets subreddit have galvanized an army of retail traders, marching in the same direction and targeting companies with large short interest. The Reddit-fueled surge in GameStop shares has burned a handful of high profile hedge fund firms that were short the stock. Shares of GameStop, which started the year around $19 per share, have surged more than 1,625% to close at $325 on Friday.

“It builds on itself — not only is it entertaining, not only is it gambling, but then all of a sudden it becomes a social war, where it's like the rich versus poor, it's hedge funds versus the little guy. And none of it would be possible if it weren't for easily available credit because the other thing that facilitates it is really inexpensive margin and all the brokerage houses alongside fee-less trading,” Cecchini noted.

He also pointed out that no fee trading is available because market-makers like Citadel Securities pay for order flow data from Robinhood.

“You can't expect to trade your options for no fee if there's not a trade-off, that trade-off is that the market-makers see the flow, period. So, look, I think it's all about to unwind, I really do. I think it's just such a mess at this point that, that game is over,” he added.

Julia La Roche is a correspondent for Yahoo Finance. Follow her on Twitter.