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What’s Really Happening with GameStop’s Short Squeeze
Almost every corner of the Internet is now filled with talks about GameStop, especially Reddit and Twitter. You would have to be living under a rock to not be aware of the Internet talking about it.
People used to create memes about how GameStop will pay peanuts for their second-hand consoles and games. But this time, it’s a different kind of meme.
GME, the ticker symbol for GameStop, have been gradually declining from 2014 where it was around $45 per share and at its lowest point reached $2.57 on 2020.
Fast forward to January 2021, GME reached around $510 per share on 28 January 2021 when it was hovering around $10 just 3 months ago and even under $5 half a year ago.
So how is this possible? It’s not like GameStop is suddenly gaining 100x more revenue compared to six months ago, and it’s definitely not switching to producing Electric Vehicle or something similarly futuristic — I’m looking at you, Tesla.
The media has tried to paint it as a meme stock, a bubble waiting to burst, a pump-and-dump scheme coordinated by people of Reddit.
GameStop Is a Bubble in Its Purest Form
GameStop is the platonic ideal of a stock bubble. A combination of easy money, a real improvement in the company’s…
The reasoning behind it goes deeper than Redditors trying to pump the price of this specific GME stock. Way deeper than that.
It is a brilliant move that is backed by numbers.
To those unfamiliar with the term shorting, it is a technique in investment that will give you profit when the share price of a company goes down.
Let me give you an example.
Alice has 10 apples, and Bob has no apples. Currently, the price of apple is $1 each. Bob wants to “borrow” Alice’s apples and promises to replace her apples later.
Alice wants Bob to pay $0.1 for every day he hasn’t returned all the apples and they reach an agreement. Now, Alice has 0 apples and Bob has 10 apples.
Bob then sells all the apples to people at $1 each and he gains $10 that day.
Five days later, the apples went on sale in the supermarket for $0.5 each. Bob goes to buy 10 of them at a cost of $5, and gives them back to Alice plus an interest of $0.1 x 5. In this scenario, Bob’s total cost is $5.5, so he gains a profit of $4.5.
Another possibility is that the price of apples instead went up to $2 each. In this scenario, Bob needs to pay $20 to replace Alice’s apple plus the same $0.5 interest. which means he lost $10.5 in the process.
In the investing world, the apple is the share of a company, and Bob is the short-trader. When someone shorts a share, they need to pay interest on top of the share cost they are borrowing.
The best case scenario for short-traders is when the company goes bankrupt, which means the company’s stock has become pretty much worthless.
Shorting is usually done towards companies that are declining or projected to be bankrupt in the future. This will increase the chance that the short-traders will be successful in shorting a company.
GameStop has been declining due to multiple factors, such as people buying games digitally instead of physical discs and the tendency of ordering a console through Amazon to get it delivered to your door instead of having to pick it up in a brick and mortar store.
A once big company that is slowly decaying to its death. It seemed like GameStop is the perfect company to be shorted, right?
The short-traders agree with this, and they start shorting GME heavily.
Too heavily, shall I say.
GME ended up being shorted by more than 100%, around 140% even.
What does this mean? How is it possible to short more than 100%? Let’s go back to Alice and Bob. We will add Charlie and Diane into the story too.
Alice has 10 apples, Bob borrows all 10, and now Alice is entitled to 10 apples and Bob has 10 apples.
Charlie wants to buy 10 apples from Bob. He buys all 10 apples from Bob, so now Alice is still entitled to 10 apples, Bob has 0 apple, and Charlie has 10 apples.
Diane wants to borrow 10 apples from Charlie, and Charlie agrees under the condition she returns the apples back to him in the future. Now, Alice is entitled to 10 apples, Bob has 0 apple, Charlie is entitled to 10 apples, and Diane has 10 apples.
From the original 10 apples, now there are a total of 20 owed apples and 10 apples which sum up to 30 “apples” in total. In this case, the apple is shorted by 200% (20 owed apples compared to 10 real apples)
It might seem silly, but it is technically possible to do this when the short-sellers are borrowing stocks to be shorted to each other.
In reality, these shorts will further keep the price of GME down, getting them closer to their goal of GameStop declaring bankruptcy.
This is the part where it gets interesting.
There is a risk in shorting a company. When the stock price goes up, the short-trader has to take a loss based on the difference of the initial price and the current price. Just like when Bob had to pay $20 instead of the original $10 for the 10 apples.
What if the price goes much higher than expected?
Going back to when Alice agrees to lend 10 apples to Bob, but this time Charlie and Diane knows about the agreement. They realise that they have a way to make profit from the fact that Bob needs to return 10 apples to Alice.
Bob sells the apple to Charlie, and Charlie keeps the apple. Now, Alice is entitled to 10 apples, and Charlie has 10 apples.
Both Charlie and Diane then go to the supermarket and buy all the remaining apples. Let’s say there are 40 apples and both of them buy 20 apples each. Now, Alice is still entitled to 10 apples, Charlie has 30 apples, and Diane has 20 apples.
When Bob went to the supermarket to buy apples, he can’t find any since all of the apples had been bought by Charlie and Diane. On top of that, there will be no more apples sold anywhere else in the world. Bob knows about this, and he tries to buy some from Charlie and Diane.
Both Charlie and Diane refuse to sell any apple for less than $1,000 each.
Bob remembers that he has to pay interest for every day he owes apples to Alice. Knowing that the loss potential is infinite when he does not return the apples to Alice, Bob decided to pay $10,000 for 10 apples.
In this scenario, Bob suffers a huge loss by not being able to find any apples for sale under $10,000.
If Charlie and Diane decide to sell an apple at $1,000,000 each and all four of them could live forever, Bob will choose to pay $10,000,000 for 10 apples instead of waiting the borrow interest to pile up.
This is what we call a short squeeze.
The risk of loss in shorting a company is infinite and this is possible when this exact scenario happens.
Back to GME with its 140% shorted position, it opens up a possibility of a short squeeze happening if and only if enough shares are kept away from the reach of the short-traders.
Wall Street Bets & GameStop
Enter Wall Street Bets (WSB), a subreddit for people sharing their personal views in investing mixed with screenshot of their portfolio both losses and gains from trading stocks.
Over a year ago, back in 2019, one particular Reddit user was posting his positions on GME and explaining that GameStop should have been valued over $8.
He was ridiculed in his early posts from 2019 to mid-2020. A lot of people doubted him and laughed at him when he posted screenshots of his loss between early-2020 to mid-2020.
I’m talking about this now famous Reddit user, whose posts have been upvoted and gilded by hundreds and thousands of people lately.
In late 2020, Ryan Cohen expressed his interest in GameStop and drove the price even higher. Cohen is the founder of Chewy, an online retailer for pet-related products that was acquired for over 3 billion USD.
Cohen will later be joining the board of directors for GameStop along with 2 other former Chewy board members.
At this point, GME was hovering around $18 and shot up to $40 shortly after. People in Reddit also started posting about the alleged possible short squeeze, which drove the price even further.
This is not a financial advice.
The media started painting WSB as a place where people coordinate and pump the price of GME. If you go to WSB now, you will see a lot of comments stating “This is not a financial advice” as a sign of protest towards these claims.
We like the stock!
People in WSB also started saying “We like the stock!” and its variations. They suspected people in Wall Street are mining sentiment data from their threads and posted a lot of positive sentiment sentences to keep the sentiment analysis result positive.
At first you might be confused what do these emojis meant. They started telling people to diamond-hands their stocks, which means to keep holding the stocks even if the price dipped.
The last week of January 2021 was where it all blew up. GME closed at 65.01 on 22 January, and at 325.00 on 29 January.
On January 27, right after the market closes, Elon Musk tweeted along with a link to WSB.
GME was having trouble getting past the $150 wall throughout the day. Elon Musk’s tweet drove up the price from $145 to $350 in the after market trading.
It was not a smooth sailing though, the hedge funds who shorted GME started pulling all sorts of plays. The most prominent one is the short ladder attack, where the hedge funds are selling shares between each other at a gradually descending price and causes the price tick to go down significantly.
This could trigger panic selling because people will think that the price of the stock is tanking and they will sell to minimise losses. It could also be used to trigger people’s stop losses.
Stop loss is a mechanic provided by brokerages. It allows people to set a price limit where their shares will be automatically sold once the price falls below the specified limit.
You could see it clearly during 28 January where the price took a deep plunge from $400 to as low as $120. Even though the volume is very low, the price managed to go down by 70%.
The short ladder attacks are very effective in driving the price down, but it will cost them quite a lot since they need to trade multiple times at a gradually lowered prices.
This will also trigger a trading halt every time it is done since the price will drop significantly in a short time.
I have never seen a trading halt before, but with GME it is almost a daily occurrence.
The trading halt is a fail-safe system by the SEC (U.S. Securities and Exchange Commission) to help stabilise volatile stocks. It will stop all trading activities once the price changes more than 10% in the last 5 minutes.
Once it is triggered, the share’s price will be frozen for 5 minutes and no buy or sell order will be processed.
The incident on January 28 was suspected as a coordinated attack by the hedge funds against retail investors. Multiple brokerages are restricting the trading of Reddit’s favourite stocks including GME.
These brokerages only allow closing activities such as exercising options and selling shares, but not allowing any buying activities. Robinhood was the one in the spotlight, since it was the most popular app among WSB users.
People started flocking to other brokers, the most prominent ones being Fidelity and Vanguard. They also gave one-star reviews for Robinhood app, which was later deleted by Google.
This causes an even bigger uproar, with Alexandria Oscasio-Cortez calling this manoeuvre unacceptable.
By January 29, Robinhood allowed trading of GME again, but with a restriction of maximum 5 shares for each user. Users with more than 5 shares of GME are still not able to buy more shares.
There are a lot of other tricks performed by the hedge funds in keeping the price down such as trying to push other stocks as “the-next-GME”, such as BB, NOK, and AMC in hope of curbing people’s interest in GME.
I will not cover their tricks extensively in this post, but I will write another story focused on them separately.
The media started saying that the short squeeze is over, that the people have won and should stop before anyone got hurt.
With GME closing at $325 on January 29, it will be anyone’s guess at which point it will close on February 5.
Is the squeeze over? Or is it just starting? One thing for sure is someone has sold GME for over $5,000 per share.
Power to the traders.