What is GameStop?
GameStop is a small bricks and mortar gaming retailer in the U.S. Due to the general move to online buying and the Covid-19 pandemic, they have been struggling, thus at the start of this year, their share price was low.
Portfolio managers at hedge funds such as Melvin Capital predicted that GameStop will continue to struggle and that its stock price would fall lower. Many hedge funds had taken a short position on GameStop, predicting that it would struggle.
What Is a Stock Short Position?
When you buy shares in a stock, you are effectively betting that the stock price will increase. A short position is a way for investors to bet that the stock price will decrease. When a hedge fund takes a short position on a stock, they borrow the stock from someone and immediately sell it at the current market price. They then wait until the stock price falls and buy it back at the lower price to return to the lender, pocketing the difference.
For example, if a hedge fund borrows 100 shares of a stock worth $20, they would sell it immediately and have $2,000. They would then wait until the stock falls and repurchase the 100 shares, perhaps at $15 per share. They would return these stocks worth $1,500 back to the lender and would have made $500.
Taking a short position is a very risky move, and is often likened to gambling. The borrower will always have to purchase those shares back to return them and there is no guarantee that the price will in fact drop. Also, the borrower pays interest every day until they repay the stock, so it is risky for a borrower to hold their short position, hoping for it to drop.
If you have seen the movie the Big Short, this is the perfect illustration of a short position. However, instead shorting the financial sector, what is happening is a short squeeze. Some of the Redditors on r/wallstreetbets are referring to this event as the Big Long.
What Is a Short Squeeze?
A short squeeze refers to the stress placed on a borrower when the share price rises instead of falls. The longer a borrower takes to repay the shares, the more interest they have to pay, thus eating into their possible profit margins. As borrowers abandon their short positions and buy back stock at higher prices, it causes the stock price to rise and therefore brings more investors to the stock.
On the 11th of January, the share price of GameStop was just under USD$20. On the 13th of January, the share price of GameStop had risen to just over USD$30. While the initial rise could be attributed to the announcement of three new directors, the Reddit r/wallstreetbets jumped on board and skyrocketed the stock to its high of USD$347 on the 27th of January.
R/wallstreetbets is a Reddit subforum which discusses stock picks and the movement of the market. So, why did Reddit rally behind a little known gaming retailer? The Big Long actually started months ago when r/wallstreetbets noted the large number of shorts on GameStop stock. A number of users on the subreddit believed that the stock was undervalued because of the shorting and tipped it as a good investment unless the shorting drove the stock into the ground. In fact, Michael Burry of Scion Asset Management, the investor who predicted the financial crisis of 2007, had bought 3 million shares of GameStop back in 2019 and stated that people were undervaluing the business. His prediction was made because even though there were now subscription game services, the PX4 and Xbox One were being made with disk drives.
Once the stock began to rise after the announcement of the new directors, r/wallstreetbets realised that the hedge funds were losing their short positions and that if they co-ordinated, they could increase the pain by driving the stock price up further. Thus, the Big Long was created. By the 20th of January, GameStop share price was USD$40, and the hedge funds were starting to make some noise about their position.
Robinhood Trading App
Robinhood is a mobile trading platform popular with small investors as it is low-free in comparison with other trading platforms. It is no surprise then that many Reddit users were using Robinhood to buy and sell GameStop shares as part of the Big Long. On the 28th of January, in response to the surge of trading on GameStop, Robinhood temporarily disallowed trading of the stock. This action caused the share price to fall to USD$193.
Redditors were furious and accused Robinhood of trying to lower the stock price. Both r/wallstreetbets and the press were quick to point to Robinhood’s ties with Citadel, one of the biggest players on Wall Street. In fact, one of the main ways Robinhood makes money is by charging Wall Street firms fees to view the trading data of its users. In terms of volume, Citadel is by far Robinhood’s greatest partner.
Vlad Tenev, the CEO of Robinhood, was quick to deny the accusations and said the temporary restrictions were just due to market regulations such as clearinghouse deposits. On the 29th of January, the restrictions were lifted, and the share price of GameStop promptly rose to USD$325.
Two LA law firms, Pessah Law Group and Chelin Law Firm, have filed a class-action lawsuit against Robinhood stating that the company breached its duties to investors by disabling critical trading functions.
Photo: Steven Cohen’s of hedge fund Point72
Hedge $20,000,000,000.00 (Billion) Loss
As it currently stands, the hedge funds are playing a high stakes game of chicken against r/wallstreetbets. They have lost an estimated USD$19 billion, and those losses are causing a ripple effect on the rest of the stock market. Hedge funds often have significant positions in index funds, so their losses in GameStop are affecting the confidence in their positions of index funds. The SMP500 and Dowy have declined, which the press and Wall Street are trying to blame on r/wallstreetbets.
Redditors and people like Elon Musk are in turn saying that the blame falls squarely on the hedge funds unwillingness to cut their losses. Their argument is that usually, billion-dollar hedge funds have all the buying power and can influence the price of shares by taking a co-ordinated approach to buying and shorting certain stocks. R/wallstreetbets is simply doing the same thing. They are co-ordinating to raise GameStop share price when it was undervalued and uncovering the corruption of Wall Street hedge funds who profit from betting against a company’s success.
New York Mets owner and billionaire investor Steve Cohen, seen by small investors as an enemy in the GameStop stock drama this week, deleted his Twitter account because of what he said were threats against him and his family, a spokeswoman said on Saturday. Cohen’s $20 billion hedge fund – heavily shorted Gamestop – and has an estimated loss of 15% since the start of 2021 because of the Reddit army targeting Gamestop.
How Long Will GameStop Continue?
It is unclear how long this event will continue, as of today, contributors to r/wallstreetbets are encouraging their fellow Redditors to hold their shares. Currently, there are no shares left for hedge funds to buy, putting them in a tricky position of paying out interest every day they don’t repay the loan. The press is reporting that r/wallstreetbets have moved on to silver, but the subreddit is clear that the message is not coming from them. They theorise that it is a conspiracy to muddy the waters and get people to release their positions in GameStop.