Everything About the GameStop ‘Short Squeeze’ Simplified for You

Last Updated on 2021-01-31 , 3:02 pm

Even as we are paying attention to the Covid-19 vaccinations in Singapore, the drama of a modern-day version of Robin Hood is playing out at Wall Street.

The opponents: Small investors (or retail traders), people who trade for their own personal accounts like you and me, vs hedge funds, money pooled by professionals and companies that make a living by trading.

Before we get into the meat of the incident, let’s get a few definitions out of the way.

Shorting

Shorting is a risky, but less capital-intensive way, to earn money on the stock market.

Basically, what happens is that you’re betting for certain stock prices to fall in the next few months.

Here’s a simple example:

Today, an S20 Ultra goes for $1,000. But with S21 coming out next month, you know that the price will fall to $800 in six months’ time.

So what do you do?

You go to a retailer and borrow one S20 from them, and sell that S20 for $1,000.

Six months down the road, you buy an S20 at the price of $800 and return the unit to the retailer.

In effect, the difference between the original and the current selling price, which is $200, would be your profit.

So, you’re wondering, that sounds plausible and risk-free, so why is there a risk?

The scenario above is the best-case scenario.

Worst-Case Scenario:

Now, imagine you forecast wrongly and the price of S20 increased to $1,500 because S21 had some issues, like exploding batteries.

This means that you borrowed and sold an S20 for $1,000, but now you have to spend $1,500 to return the unit.

That difference now turns into a loss of $500.

With me so far? Good.

Now, multiply that loss by a few hundred times and you’ll see the true scale of the battle happening at Wall Street.

What Happened At Wall Street

GameStop is an American chain of video game stores, and in recent years, they’ve been suffering losses due to competition from online businesses like Amazon and Netflix.

It didn’t help that 2020 happened and the Covid-19 pandemic resulted in lesser people coming out to shop.

This led to a decline, leading many investors to short-sell GameStop stocks in the market as they all expect the company to go under.

Sounds like another one biting the dust, no?

In September 2020, Ryan Cohen, the former CEO of an online food store, invested in the company.

He acquired 13 per cent of the business and urges it to go online and compete against the giants.

Still, investors on Wall Street (i.e. people who manage hedge funds) think it’s likely to fail.

So there you go; an opportunity to short. Investors knew the company is likely to fail, and thus, decided to short the heck out of it.

Many shareholders at GameStop were approached to borrow their shares and these shares were immediately sold on the market, with the investors expecting the price to drop and buy it back later at a lower price.

Unfortunately, something happened.

Enter Reddit

Shortly after the comment by Citron Research that the share price of GameStop will drop, Redditors on r/wallstreetbets initiated a short squeeze on GameStop.

Basically, what they did was to utilise the power of the masses by initiating the buying and selling of GameStop stocks among themselves to increase the share price.

If you remember the best-case and worst-case scenario above, this basically means the small investors (like you and me and Ah Hock) are initiating the worst-case scenario for those who are attempting to short GameStop shares.

After all, if the price of buying is higher than the original price of selling, that difference would turn from “profit” into “loss”.

And oh, boy, what a loss.

Almost US$500 Per Share

On 1 Jan 2021, GameStop shares opened at USD19 (S$25.29) and closed at USD17.25 (S$22.96).

On 27 Jan 2021, GameStop shares opened at USD354.82 (S$472.35) and closed at USD347.51 (S$462.62).

It didn’t get any better the next day either, and GameStop shares hit a high of USD483 (S$642.99).

And because hedge funds are known for playing big, you know they don’t play with one or two shares.

Huge Losses

Melvin Capital, an investment firm which betted heavily on GameStop declining, lost 30% of its USD12.5 billion (S$16.64 billion) that it is managing.

They pulled out of the battle after taking a huge loss.

Other hedge funds had to come in and rescue Melvin Capital with a USD2.75 billion (S$3.66 billion) bailout.

It’s not the only one either as Citron Research, the one which predicted the fall of GameStop, closed their shorting position with “100% loss”.

Andrew Left, the founder of Citron, reportedly said it’s due to harassment by GameStop supporters.

The total loss due to the squeeze is USD5.05 billion (S$6.72 billion), according to Short Sight.

Huge Winners Too

Just as there are losses, there are winners in this battle as well.

The final winners are, of course, the dudes and dudettes who loaned out their stocks in the first place, provided the share price does not drop before they are returned the shares.

The owners of GameStop shares might also stand to benefit from the surprising windfall instigated by the battle.

Retail investors who bought into the battle are also huge winners.

After all, if you think about it, they’ve essentially “gone long” on their trading strategy.

Basically, what this means is that you buy shares at a low price, anticipating it to rise in value, and sell it at a higher price in the future.

And if they’ve bought the shares at USD19 (S$25.29), the value of the stocks they hold now is 1,600% higher than what they’ve bought it for, if they sell now, that is.

One r/wallstreetbets trader said they’ve turned USD50,000 (S$66,562) purchase into USD11 million (S$14.64 million).

Aftermath

Investors and hedge funds are criticising the movement but they are, in turn, criticised by well-known and high-value figures, including American senators and Elon Musk.

On 26 Jan 2021, Musk tweeted “Gamestonk” on his Twitter account, leading to a spike in GameStop share price (again).

Gamestonk!! https://t.co/RZtkDzAewJ

— Elon Musk (@elonmusk) January 26, 2021

While several hedge funds have chosen to pull out before they incur greater losses, other investors are holding on, hoping that the price of GameStop shares would eventually drop.

On 28 Jan 2021, the price of GameStop shares finally declined after 6 days of crazy increase, after retail brokerages Robinhood and Interactive Brokers reportedly restricted trading.

Meanwhile, financial experts advised owners of GameStop shares to unload their stocks while they can for a tidy sum of profit and move on.

After all, you never know when the bubble would burst.

And if you understand everything here, you should know that the stock confirm-plus-chop will drop, since it’s gone up not because the company has become more valuable, but because, for a lack of a better word, it has gone “viral”.

We all know a viral content by an influencer isn’t going to make an influencer rich.

Feature Image: Jonathan Weiss / Shutterstock.com