What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing i'm sure you all remember the gamestop and amc short squeezes from earlier, where individual investors made billions of dollars at the expense of hedge funds. In the case of gamestop, so many hedge funds were short that many shares were shorted multiple times. This led to a situation where more than 100 of the outstanding shares were shorted, leaving them massively vulnerable to a short squeeze. But honest investors weren't the only ones who made money from the short squeeze saga.

The sec recently uncovered unscrupulous actors who took advantage of the unprecedented market volatility and meme stock options to make hundreds of thousands of dollars. They did this by employing a sophisticated and highly technical scheme. They took advantage of arcane rebate structures offered by options, exchanges to book massive profits from fake trades and meme stock options at the height of the february volatility. Their actions have the effect of manipulating the markets and exacerbating the volatility in this video we'll go over how this manipulation happened, how the masterminds profited from it and how they were finally caught to understand this scheme.

We first have to understand the technical aspects of how options are traded when the hyper on gamestop started in early 2021 volumes of gamestop options. Exploded options are far less liquid than stocks, making it much more difficult to get good execution at the time of recording this video gamestop trades for 189.48 per share. If you put in order to buy one share, the amount you'll be charged will be pretty close to the quoted price, but this is not the case for options. For example, take a look at this gamestop option.

The price is quoted at being 54 cents, but it's unlikely you'd actually be able to buy or sell for this price. If you wanted to buy it immediately, you'd have to pay 65 cents, which is the ask price. If you wanted to sell immediately, you would only receive 42 cents, which is the bid price. The spreads are typically very high for out of the money options.

The options exchanges such as sibo make revenue via transaction fees, the more trading that occurs, the more money they can make. Thus they want to make their options markets as liquid as possible to help facilitate frequent trading. That is, if you put a limit order in, they want to be filled as quickly as possible. They are especially keen to increase the liquidity of high volume options that are getting a lot of interest from investors.

To this end, many exchanges operate so-called maker taker schemes which incentivize market participants to add liquidity to the markets. This example shows how a make-or-taker scheme works. Let's say, there's an option where the best bid is one dollar. This is the highest price that someone is willing to buy it for right now.

The best ask price is one dollar and ten cents, which is the lowest price. Someone is willing to sell that. As you can see, there is a 10 cent spread. The exchange wants to reduce the spread as much as possible.

Let's say you put it in order to sell the option for one dollar and five cents. This will not immediately get executed because it is above the highest bid of one dollar. It is also below the lowest ask of 110.. Thus, your one dollar and five cent sell order would become the new lowest asking price which will decrease the spread from ten cents to five cents.

The exchange will compensate you for reducing the spread by paying you a rebate of a few cents. Now, let's say you want your sell order to execute immediately, so you set your limit sell price at one dollar. This is equal to the highest bid price. So your trade will be executed because you took out the highest bid.

The spread has now increased from 10 cents to 15 cents, because you widen the spread. The exchange will charge you a fee of a few cents. It's not terribly important that you understand the technicalities of how this works. Just remember that some options transactions earn a rebate, while others incur a fee, and these fees become greater for out of the money options with large spreads and when trading volume is high, as was the case with the memes talks in february of 2021.

A florida resident by the name of soo yun gu took notice of the extreme volatility in various memestocks, such as gamestop and amc. He realized that this volatility would increase the rebates they could potentially earn by trading their options. Some of the biggest rebates available were for deep out of the money options with wide spreads, but there were two problems he had to overcome. Firstly, these deep out of the money options had very little volume, so he couldn't make that many trades on them and, secondly, buying options on meme stocks is very risky.

If the stock moves unfavorably for his position, he could incur losses far in excess of the few pennies he would receive in rebates for each trade. He thought of a brilliant idea that could solve both these problems and allow him to make hundreds of thousands of dollars with almost no risk. He contacted his associate jung lee to help him implement the scheme. He would choose deep out of the money, put options that were thinly traded.

Then he would place orders that decrease the spread of the position and thus collect a rebate. Remember that this is called a maker trade. His associate young lee would act as his counterparty and take the other side of the trade. Lee's trades constituted taker trades as he was widening the spread by filling goo's orders since they're only trading between each other.

They do not hold any net position in the stock and thus are not impacted by the movements in the share price. The taker trades incurred fees from the exchange that would be equal to or exceed the rebates that the maker trades make at first glance. This might seem odd if the fees from these taker trades offset the rebates from goo's maker trades. How can they make a profit? This is where the other part of their plan came in some brokerages, such as interactive brokers, pass along the rebates from the exchange to the customer.

We don't know which brokerages they were using. Interactive brokers is just an example. Other brokerages don't pass on exchange, rebates or fees onto the end customer. They just collect the rebates and pay the fees themselves.

Under normal circumstances, the rebates and fees would roughly cancel out, so the brokerage doesn't gain or lose anything by keeping them these two coordinated their trading, such as the one making the maker trades, was using a brokerage that passes on the rebates to the customer, the one Making the opposing taker trades would use a brokerage that internalizes the fees effectively, they could have their cake and eat it by collecting the rebates, but not paying the fees. The only problem with this strategy is that it's completely illegal they're, effectively robbing the brokerage by saddling them with fee generating taker trades. After successfully running the scheme for a while, the brokerages, they were using start to get suspicious of their unusual trading activity and terminated their accounts, but they are making way too much money for this to stop them. They open new accounts by using fake names and vpns to conceal their identities.

According to the sec, goo made a grand total of more than 11 400 trades, which netted him a profit of more than six hundred thousand dollars. Lee made 2 300 trades, naming him more than 50 000 in ill-gotten gains, and it wasn't just the brokerages that they victimized their scheme resulted in certain out-of-the-money, put options appearing much more heavily traded than they actually were. This appearance of liquidity may have baited other investors to trade, these same options when they otherwise would be unlikely to do so. The sec has charged both individuals with securities violations.

Lee agreed to discourage his fifty thousand dollars in profits and pay a civil penalty of twenty five thousand dollars. It does not appear that any criminal charges have been filed against either of them. At this point, this story should serve as a cautionary tale to anyone who trades options as compared to the more tame world of regular share trading options are like the wild west. The low liquidity makes them prime targets for market manipulation and other schemes which can rob your money without you, even knowing alright guys that wraps it up for this video.

What do you think about this market rigging scheme? Do you think this or any other manipulations, contributed in any way to the memes top short squeezes that we saw at the beginning of this year? Let us know, in the comments section below, if you enjoyed this content, make sure to hit the like button and subscribe. So you don't miss future uploads as always. Thank you so much for watching and we'll see in the next one wall, street millennial signing out.