Meme War: GameStop, Hedge Funds & The Battle For Wall Street

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What happened to GameStop stock was arguably wilder and more exciting than some of the video games it sells.

GameStop’s 

• GameStop (GME) stock was trading around $18 in early January 2021
• Elon Musk tweets “Gamestonk!” which drew extra attention to the whole phenomenon 4:08 PM · Jan 26, 2021 
• Doubled in four days
• Continued doubling until it reached $483 on January 28th — jumping more than 1,000%
• Elon Musk tweets about short selling on January 28th
• Stock fell to $193.60 on the 29th, down 44%
• Remains 1,250% higher than the beginning of 2021

GameStop was chosen by a fearless few to teach the big boys a lesson — here’s what happened

Or WSB as its known on the streets…of Reddit, has a self-proclaimed King and his name is DeepF*ckingValue. I’m serious. Look up his profile name. This mysterious user bought a mix of $50-100k worth of Gamestop ($GME) stock and options. In less than 12 months, his single stock portfolio skyrocketed to $47 million!

Vijar Kohli

What is a Short?

• ENTITY ONE owns 5 WIDGETS
  • 5 widgets cost $18
• ENTITY TWO ASKS ENTITY ONE to hold their widgets for a bit
  • Instead of holding the widgets, they sell them for $18, because they believe the price will go down soon. Then they can re-buy the widget at a lower price.
• AN ANONYMOUS GROUP Sees what ENTITY TWO is trying to do so, they buy all of the available widgets, This drives up the price to $350, forcing ENTITY TWO to buy 5 widgets at a much higher price to return ENTITY ONE’S initial 5 widgets
  • 5 widgets cost $350
• AS long as AN ANONYMOUS GROUP doesn’t sell the price will remain high

Sweet Revenge: Death By Short Squeeze

• Who: 
  • Redditors in a group called r/WallStreetBets discussed which big trade to jump on to make Wall Street hedge fund managers lose money
  • Redditors chose GME
    • Has more than 5,000 brick-and-mortar stores selling video games 
    • Struggling during the pandemic — keeping customers away and shopping online
    • Expected to keep losing money in the next fiscal year
• How: 
  • Hedge funds and professional Wall Street investors despised GME stock and were betting on its stock to fall by “shorting” it
    • Investors borrow a share of GME stock and sell it
    • Wait for the price to drop and buy the stock at a lower price
    • Return the stock and keep the difference
  • Because GME stock was heavily shorted
    • Sudden rise in price (caused by Redditors purchasing activity) is forcing sellers to get out of their bets by 
    • Buying the stock
    • Which is driving stock prices even higher, creating a feedback loop
  • Result: Wealthy short sellers are being squeezed — or losing money
• What: Options and margin trading:
  • Buying stock “on margin” allows investors to use borrowed money, supercharging their gains and losses
  • Options allows an investor to buy the right to buy the stock at a later date and at a certain price
    • If the stock reaches the agreed upon price, the investor reaps a bigger return than if they just bought a share
    • If the stock doesn’t reach the agreed upon price, investors reap a total loss
• Why: Redditors claim the strategy isn’t about greed, but about “taking back what’s ours, what we’ve already paid for,” according to one user
• Where: Investors initially set their sights on GME, but are now looking for the next GME — Blackberry, American Airlines, AMC Entertainment Holdings, and others

As the Redditors’ strategy played out, squeezed investors started to wonder what happened

Counting The Losses

• Critics of the redditors’ strategy believed the mainstream market would not be affected
• Until the S&P 500 fell by 2.6% on January 27th — worst stock market day since October 2020
• Due to short sellers selling some of their stock holdings to raise cash

Regulators To The Rescue?

• The Securities and Exchange Commission (SEC) is monitoring the current market situation
• Wall Street investors believe GME investors holding its overpriced stock will be hurt the most once the price falls
• Though the r/WallStreetBets redditors have publicly communicated their desire to push GME even higher, they have not done anything illegal
• The best strategy may be to educate novice investors about the risks of stock bubbles and overzealous trading

Why The Forecast Was Wrong

• Market analysts did not anticipate such a strong market reaction to the redditors’ GME strategy
• Barriers to trading have fallen:
  • Commissions are zero
  • Apps let anyone trade on a smartphone

A leading trading app, Robinhood, is being blamed by both sides for its response to the GME price jump

Robinhood’s Controversial Role

• Initially blocked purchases of GME and other companies driven up by social media users, but then reversed its decision
• Announced on the 28th that it would allow “limited buys” of GME stock and other names popularized by redditors
• Called it a “risk-management decision” and cited its “financial requirements” as a broker
• Tapped into its credit lines to bolster its financial stability
• Critics say Robinhood’s decision is:
  • Creating opportunity for investors to continue creating stock bubbles
  • Causing investors to worry about the integrity of the marketplace and clearinghouses, which:
    • Stand at the center of short trades, guaranteeing payment if either side defaults
    • Require members (banks and brokers) to deposit collateral and pay into a default fund
    • Must have sufficient capital to cover losses
    • May need to collect from other members if the situation worsens
• Robinhood faces potential legal liability for its earlier decision to restrict trading
  • New York lawsuit seeking class-action status alleges the company manipulated the market by limiting users ability to buy GME and other stocks

And finally, the platform at the center of it all — Reddit — is getting angry glares for letting users plan to squeeze wealthy Wall Street investors and hedge fund managers

Social Media — A Favorite Scapegoat

• When the pandemic forced people into lockdown and caused a market crash, social media users found community online
• What started as a group of people on a subreddit trying to make a profit turned into a movement
• r/WallStreetBets moderators briefly stopped posts before allowing them to continue on Wednesday, the 28th
• Though squeezed investors would like to see these users held accountable, it would be difficult to:
  • Argue that Redditors were part of an illicit scheme to manipulate the market because they were publicly discussing which stocks to buy
  • Prosecute anonymous users

Though the Redditors have not done anything obviously illegal, the GME stock price hike is raising important questions about market regulation

GameStop? Game On!

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Sources:

• https://www.msn.com/en-us/money/companies/explainer-why-gamestops-stock-surge-is-shaking-wall-street/ar-BB1dbqoQ
• https://www.foxbusiness.com/markets/why-gamestops-stock-surge-is-shaking-wall-street
• https://www.marketwatch.com/story/peterffy-calls-robinhood-decision-to-allow-limited-buys-of-gamestop-troubling-im-not-comfortable-11611876619
• https://www.msn.com/en-us/money/savingandinvesting/robinhood-under-fire-after-flip-flopping-on-gamestop-shares-what-role-did-tech-play/ar-BB1dbHwC
• https://www.linkedin.com/pulse/how-main-street-stormed-financial-capital-gamestop-story-kohli/
• https://twitter.com/elonmusk/status/1354174279894642703
• https://twitter.com/elonmusk/status/1354890601649610753