The internet and the stock market are on fire over GameStop, the video game retailer whose stocks are suddenly the darling of the day traders who pressure Wall Street’s big players.
The stakes are huge: the surge in trade added more than $ 10 billion to GameStop’s value on Wednesday alone. On Thursday, when multiple trading platforms temporarily restricted shares, stocks fell 44 percent and rose again on Friday after trading restrictions were eased.
Why GameStop’s value has soared to stratospheric levels – at least on paper – has to do with a mix of traditional investing, rampant enthusiasm, stock market mechanics, and the belief that anyone with a Robinhood account can make a fortune.
It’s known as a short squeeze, and it involves investors betting on which way a stock will go up or down. These bets are placed by buying the stocks themselves or stock options, which we will greatly simplify here.
Investors who bet against a stock are known as “shorts”. In GameStop’s case, the shorts include at least two large hedge funds.
GameStop versus Wall Street
Let us understand you
- Stocks of GameStop, the video game retailer, have risen because amateur investors starting at Reddit have bet heavily on the company’s stock.
- The wave gained momentum when large hedge funds short-sold GameStop stock – essentially betting against the company’s success.
- Sudden demand pushed the stock price from less than $ 20 in December to nearly $ 200 on Thursday. At least on paper.
- It’s not just GameStop. Amateur investors have supported other companies that many large investors have shunned, such as AMC and BlackBerry.
- This bubble around GameStop can force large investors to raise funds to cover their losses or dump stocks in other companies.
Shorting a stock essentially means borrowing and selling stocks from a broker. With the agreement that you will return the shares later. When the price falls, buy back the shares and pocket the difference. However, shorting a stock is risky – you can lose a lot when the price goes up.
Sometimes you just make a bad bet. Or, you can lose if someone tries to raise the price by buying lots of stocks when the company does nothing else.
That’s the pressure.
Shorts need to close their position, which means buying up and redeeming the stocks they owe their brokers. That demand drives the stock up, and a short that trades too late could be ruined.
Typically, such battles involve highly developed Wall Street investors, such as when Bill Ackman stood up against two other billionaires – Daniel S. Loeb and Carl C. Icahn – over the dietary supplement manufacturer Herbalife.
Why did GameStop’s stock rise?
The amateurs started to raise the price.
Last year armchair dealers entered the market. Some smelled like an opportunity after stocks fell last spring, others tried to get a game itch after the sports leagues closed, and for some it was just a game – trying to earn dollars instead of points. All of this has been made easier by the free trades available through platforms like Robinhood and E-Trade.
Some of these avid amateurs buy shares in GameStop, but many place their own option bets on the opposite side of the shorts.
These bets are contracts that give you the option to buy a stock at a certain price in the future. When the price goes up, the trader can buy the stock at a bargain price and sell it for a profit. (In practice, many traders will only sell the options contract themselves at a profit or loss rather than actually buying the shares. However, this description is sufficient for our purposes.
The brokers selling the option contracts must provide the stocks if the trader wishes to exercise the option. To minimize your risk, buy some of the stocks you would need. Usually that low demand doesn’t have much to do with price.
But if enough traders bet big, demand can drive the stock higher. If it goes high enough, the brokers on the hook will have to buy more stocks so they don’t get stuck buying lots of expensive stocks at once.
That increases the demand, which increases the share price. Which means the brokers need to buy more stocks, which means the idea will come to you.
OK, but why GameStop?
You can blame Reddit’s Wall Street Bets forum, one of the weirdest places on the internet. Wall Street Bets (WSB) is where chair vendors gather to share memes, feel sorry for losses, and share more memes. But they also exchange tips and analyzes that can apply to pages.
GameStop’s shares began rising late last year after pet supply site founder Chewy bought a stake in the company and received a seat on its board of directors. The company slowly caught the attention of WSB and retailers, who frequently use the player-friendly Discord social media service.
The motivations of the traders are very different. For some reason, GameStop stock is good value. Others just ride the wave. And others want to put pressure on Melvin Capital, a hedge fund that sold GameStop short. You quote Heath Ledger’s Joker character from “The Dark Knight”: “It’s not about money; It’s about sending a message. “
But the aggressive maneuvers against the shorts aren’t necessarily limited to the amateurs. The great Wall Street players know an opportunity when they see it.
How does the GameStop squeeze end?
On Thursday, Robinhood, Interactive Brokers, and others put more restrictions on trading GameStop and other stocks that have gone mad. For example, Robinhood limited the ability of merchants to purchase calling options through their app.
These moves have drained the rally. GameStop slipped after this introduction, reversing a profit of more than 30 percent on Thursday. Then the trading app lifted some of the restrictions and stocks rose 65 percent on Friday.
A spokesman for Melvin Capital, who needed a $ 2.75 billion injection of cash on Monday because of the shortage, said the company had closed its short position. Citron Research’s Andrew Left, another short, said he covered the majority of his short position “at a 100 percent loss.”
There’s a catch: GameStop as a company isn’t noticeably different from a month ago. With any conventional measure, the share price is grossly inflated – and extremely risky for anyone who owns their shares.
But it’s no longer just about GameStop. Enthusiastic amateurs are also offering the prices of other ailing stocks such as the cinema chain AMC Entertainment, American Airlines and the smartphone maker BlackBerry.
This strange little bubble doesn’t just affect the weather, however. If large investors on the losing side of these trades need to raise money to cover their losses, it could mean dumping enough stocks to hurt the prices of otherwise solid stocks.
If the sell-off is big enough, it can have a cascading effect that leads to bigger losses for investors who have never bought or sold a stock of GameStop.