Building Wealth If you had an "infinite money cheat code," would you use it?
You could deposit $2,000 and turn it into $20,000, $50,000, or even $1 million in moments...
And you could put that money in a single stock and watch it grow into thousands of dollars in profits for you with one small move...
While this "cheat code" might seem unrealistic, it did exist...
The online message board WallStreetBets is hosted on the popular news aggregator and discussion website Reddit and has become a home for investors who make risky bets and share information and opinions about them.
The message board is a collection of investment tips, bragging, quite a few memes, and of course... overconfident young traders.
Let me (Jeff Havenstein) give you a quick example...
In 2018, a 24-year-old software engineer, Dennis Cao, boasted about a massive wager he'd made using the code... He bet that a few Big Tech darlings would rise after they released quarterly earnings.
Unfortunately, the trade went against him. He lost about $185,000 in one day, posting a screenshot of his losses on WallStreetBets. But no one called him reckless. Instead, other users sent positive notes, congratulating him for sharing the results of his loss.
And even this year, a few WallStreetBets members posted about the infinite money cheat code...
One user wrote that he was able to deposit $2,000 into his brokerage account and magically turned it into $50,000. (Although it didn't take long for him to lose it all on a bad bet.)
Other people shared how they used the same cheat code to greater extremes...
Two users turned their respective cash deposits of $4,000 and $15,000 into more than $1 million worth of stock, each. One trader used the method to end up more than 500 times leveraged and long more than $1.7 million in chipmaker Advanced Micro Devices (AMD).
Here's the screenshot he posted to prove it...
Posts like these were hits on WallStreetBets. They were cheered on.
As you can imagine, the message board grew in popularity during this cheat-code period...
Now, you might not be the type of person to post about risky single-stock trades on an Internet message board. So let me explain how this cheat code existed in the first place...
In short, it was a glitch in the free stock-trading app Robinhood Financial. Robinhood, which launched to the public in 2015, allows users to trade stocks on their smartphones or tablets.
Its target audience is millennials – the same generation of folks you'll find on WallStreetBets.
The infinite money cheat code existed for Robinhood Gold members, who were allowed to trade "on margin."
As regular Health & Wealth Bulletin readers know, margin can be risky if used incorrectly. Margin is a type of debt. Using margin allows you to buy shares of a stock with less upfront cash than you would otherwise need.
When successful, it can magnify your percentage gains. But it can also exacerbate your losses. And like any debt, it costs you interest, and you have to pay it off eventually.
Most brokerages allow margin debt to make up to 50% of an account's total value.
But the trade in this case wasn't the issue. It was Robinhood's software. And a small group of astute users of the app noticed a loophole...
Traders used margin to borrow money and buy shares of a single company...
Then they sold something called "covered-call options," which paid them cash immediately. Once the cash from the options sale was added to their account, it tricked Robinhood into thinking they had more cash than they actually did. That led to more buying power... We're talking tens or hundreds of thousands of dollars of more buying power.
And they repeated this infinite money cheat code over and over again.
Now, this might sound complex if you're unfamiliar with options jargon. So I'll give a quick Options 101 lesson...
A "call option" is a contract that gives the buyer the right, but not the obligation, to buy shares of a stock at a specific price before a certain date. (If you memorize that sentence, you'll sound very smart talking options at your next cocktail party.)
But basically, options are like a side bet on a stock. (You might get along with more casual investment people at the cocktail party if you describe options this way.)
A covered call means you're selling someone else in the market the right to purchase a stock that you already own.
In options, there are sellers and buyers, each making bets...
When you sell a covered call, the buyer gives you money immediately, known as the "options premium." The buyer will pay you up front and can decide whether or not they want to buy your shares.
So when you sell a covered call, you can immediately end up with $300, or $700, or whatever the options premium is... right away.
And this is how the people posting on WallStreetBets about a cheat code were able to (temporarily) take advantage. They were able to borrow unlimited amounts of money.
As you might guess, this didn't end well...
After a few days, Robinhood fixed the glitch after discovering it through the posts on WallStreetBets.
Robinhood's "infinite leverage" was under regulatory scrutiny from the U.S. Securities and Exchange Commission. And it's just one of the many reasons the broker was fined nearly $70 million dollars.
Robinhood wasn't the only loser...
Many users of this hack lost a lot of money. One trader who deposited $4,000 and had more than $1.2 million of leverage lost $22,000 – more than five times his initial deposit. We all go through the lesson (and pain) of having too much leverage at some point... But for these traders, this lesson was excruciating.
Others had a bit of fun with the hack. One WallStreetBets member posted this screenshot trying to get discount broker TD Ameritrade to offer him the same infinite-leverage ability...
The accounts that were found to have exploited the error have been suspended.
I won't lie... I had a good laugh when I read this story. But I also shook my head, knowing that it will just scare more people away from options.
Many investors already consider them a complex, risky financial instrument...
But the truth is options trading has a bad reputation.
There are all kinds of horror stories about traders losing big on options trades and getting into serious trouble.
Here's the thing... Selling covered calls and puts is a great strategy, if done correctly.
If you are curious about selling options and how it can reduce your risk in a given trade, then I suggest you watch Doc's video with professional golfer Kevin Kisner. He didn't know much about options before we sat down together, and I walked him through the whole strategy. We even made a trade using his own money.
This is your last chance to watch our video here.
What We're Reading...
- Something different: Credit card balances hit $1 trillion for the first time.
Here's to our health, wealth, and a great retirement,
Jeff Havenstein
August 10, 2023