The Money-Making Game Stops
GameStop (Ticker: GME). A store that sells consoles, games, discs, and gives you pennies for your trade-ins became one of the hottest stocks in 2021. Moving from a 52-week low of $2.57 to a high of $483 on January 28th, GME represented the transfer of stock control from institutions to individual investors. Let’s break down how this happened.
First, let’s understand shorting stocks. Shorting is a way for investors to make money when a stock goes down. Here, they borrow shares from an owner and proceed to sell these shares on the market. However, by contract, they still have to pay back the shares they borrowed from the owner, so when the stock price goes down, they purchase these shares at a lower price, returning them back to the owner, pocketing the difference.
Let me give you an example. Say a short-seller borrows one share of stock XYZ at $10 per share. The short-seller will then proceed to sell the one XYZ share for $10. He still owes the owner the one share that was borrowed. The short-seller waits for the stock price to go down to say $5, and covers his share at this price. He/she then returns the one share of XYZ to the owner, and since the shorter sold the share for $10, then bought it for $5, the profit would be $5.
This makes short selling extremely dangerous. What if the stock price went up? This would force short-sellers to cover their positions for a loss. In this example of stock XYZ, what if the price went to $30 instead of $5? Then, the shorter will have to cover his/her position for a $20 loss.
This is exactly what Reddit user, DeepF*ingValue of the ‘WallStreetBets’ group, formulated with GME, since it was one of the most shorted stocks at the time with more shares shorted than available to buy on the market. He noticed that, despite the good press that GameStop was receiving, like the 519% increase in online sales in June, and Chewy.com’s founder taking a 13% stake in the company, the price was still going down and institutions/hedge funds were still shorting the stock.
He theorized that if enough people bought GME, whether it be through a market buy or exercising option contracts, they would be able to drive the stock price up since the short-sellers would have to cover their positions. This would only be possible since GME had more shares shorted than shares available on the market. If individual investors bought these shares, they could hypothetically not sell them to the shorters who were trying to cover their positions.
Using stock XYZ as an example again, say that WallStreetBets users owned most of the stock but did not want to sell, then short-sellers would be forced to cover their positions at a continually increasing price, till someone decided to sell.
This same concept was what caused GameStop’s stock price to skyrocket. WallStreetBets users held onto their shares causing the short-sellers to offer higher and higher prices to buy it from them. This is what led to a short squeeze soaring GME to $483.00, making WallStreetBets users filthy rich while costing hedge funds billions of dollars.
Fueling this price was other retail investors pouring their money into the stock, and Elon Musk tweeting out “Gamestonk!!” to his 47 million followers. DeepF*ingValue, the user that found this abnormality in the first place had unrealized gains of nearly $22M, when he was down $50,000 just a few weeks prior.
Fast forward a couple of days, brokers like Robinhood did not allow users to buy about 50 securities like GME, NOK, and AMC since the brokers could not pay the transaction fees imposed by their clearinghouse, hence only allowed users to sell their positions. This move angered investors claiming losses of hundreds of thousands of dollars, leading to multiple lawsuits being filed against the brokerages.
What is surprising is that DeepF*ingValue who used to write numerous posts and comments a day completely stopped posting. Some even came up with a conspiracy theory that went as far as to theorize that the hedge funds and institutions had murdered him, but this is unproven. Also, the WallStreetBets community has been removed from Reddit, and the SEC and other regulators have commenced investigations into this mind-blowing short squeeze.
A few weeks later, the tug of war between individual investors and hedge funds has somewhat settled. GME is currently trading at $42, down almost 92% from its all-time high. Though the hedge fund institutions are winning currently, this event signalled a transfer of wealth and power from large institutions to individuals, and is one that will go down in the books.