AMC Bet by Hedge Fund unraveled thanks to meme stock dealers

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WSJ.com: Markets

A multi-pronged bet on AMC Entertainment Holdings Inc.

AMC 15.39%

boomed this month at Mudrick Capital Management LP, the newest hedge fund to fall victim to the swarming of day traders.

Mudrick’s flagship fund lost about 10% in just a few days when a surge in AMC stock price triggered unexpected changes in the value of derivatives the fund held as part of a complex trading strategy, people familiar with the matter said.

The setback comes months after a group of vendors organized on social media helped broadcast the GameStop award Corp.

GME 5.88%

and other stocks rose in January, well above many investors’ views on underlying fundamentals.

The development caused many hedge funds to reduce their exposure to meme stocks. Mudrick Capital’s losses illustrate how risky it can be to hold significant exposure to such companies – even backfire on a hedge fund manager who largely concurred with the optimism of individual investors.

Jason Mudrick, the company’s founder, traded in AMC stocks, options and bonds for months and drove a wave of enthusiasm for the theater chain among individual investors. But he also sold call options, derivative contracts designed to hedge the fund’s exposure to AMC should the stock price fail. Those derivative contracts, which gave their buyers the right to buy AMC shares in Mudrick for about $ 40 in the future, rose into liabilities as a resurgence in Reddit-fueled buying recently drove AMC shares to new records, said the people.

Day traders made their first run on AMC stocks in late January.


Photo:

Bing Guan / Bloomberg News

As part of the broader AMC strategy, Mudrick Capital executives held discussions with AMC in late May to buy additional shares in the company. On June 1, AMC announced that Mudrick Capital had agreed to purchase $ 230.5 million in new shares direct from the company at $ 27.12 each, a premium to what was then trading .

Mudrick immediately sold the stock for a profit, a quick move reported by Bloomberg News that sparked a backlash on social media.

“Mudrick didn’t stab AMC in the back … you shot yourself in the foot,” read a post on Reddit’s Wall Street Bets forum on June 1. Other posts at the time referred to Mudrick as a “loser,” “scum bag,” and “a great billowing bunch s — t with no future.” Forum members encouraged each other to buy and hold.

At Mudrick, managers got worried as the AMC rally gained traction. The company’s risk committee met on the evening of June 1 after the stock closed at $ 32 and decided to ditch all bond and derivatives positions the next day.

It was a day too late.

AMC’s share price soared above $ 40 in a matter of hours on June 2, hitting an intraday high of $ 72.62. Call option prices rose amid a trading frenzy that Mudrick Capital contributed to, and by the end of the week that successful trade had turned into bankruptcy. Mudrick Capital posted a return of around 5% on the bonds it sold, but after factoring in options trading, the fund saw a net loss of around 5.4% on AMC.

Mr Mudrick’s fund is still up about 12% for the year, one of the people said. Meanwhile, investors who bought and held AMC stock at the start of the year are up around 2000%.

The influence of social media-driven day traders has become a defining market development this year, costing top hedge funds billions of dollars in losses, triggering a congressional hearing, and a US Securities and Exchange Commission review attracted. Today, more hedge funds are tracking individual investor sentiments on social media and paying more attention to companies with smaller market values, whose stock prices may be more susceptible to individual investor excitement.

Wall Street is in an uproar over GameStop stocks after members of Reddit’s popular WallStreetBets forum encouraged betting on the video game dealer. WSJ explains how options trading drives the action and what’s at stake.

Mr. Mudrick specializes in distressed debt investments, often lending high-interest loans to troubled companies, or swapping existing debts for equity in a bankruptcy court. Mudrick manages approximately $ 3.5 billion in investments across the company and has large, illiquid interests in e-cigarette maker NJOY Holdings Inc. and satellite communications company Globalstar Inc.

of such exchanges. According to data from HSBC Alternative Investment Group, the flagship fund generated annual returns of around 17% from 2018 to 2020.

But distressed investment opportunities are becoming harder to find as easy money from the Federal Reserve has given even troubled companies free access to the bond markets. Mr. Mudrick has explored other strategies, established several specialty acquisition firms and, in the case of AMC, eventually bought shares in block trades.

Mr. Mudrick started out using his signature playbook at AMC, buying bonds for just 20 cents a dollar, lending the company $ 100 million in December and exchanging some bonds for new stocks. The theater visits, already under pressure, were almost entirely gone during the lockdown of the Covid-19 pandemic, and AMC shares only traded at $ 2. He argued that if more Americans were vaccinated, consumers would have an appetite for big-screen entertainment again this year.

Day traders made their first run at AMC in late January, huddling each other with the social media rally call #SaveAMC and briefly lifting the stock to around $ 20. The rising stock value of AMC drove bond prices higher – a bond owned by Mudrick Capital doubled in a week – which quickly rewarded Mr. Mudrick’s uptrend. AMC used its soaring share price to raise nearly $ 1 billion in new funding in late January, making it possible to fend off a previously anticipated bankruptcy filing.

Around this time, Mr. Mudrick sold call options on AMC stock, generating immediate income to offset potential losses should the theater chain struggle. The derivatives gave buyers the option to buy AMC shares in Mudrick Capital for around $ 40 – which was seemingly unlikely if the stock was trading below $ 10.

Mr. Mudrick stayed in touch with Adam Aron, AMC’s Chief Executive, regarding the provision of additional funding, which led to his most recent share purchase. But he kept the derivative contracts pending as an insurance policy, said one of the people familiar with the matter.

Write to Matt Wirz at matthieu.wirz@wsj.com and Juliet Chung at juliet.chung@wsj.com

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