GameStop has become the talk of the town, even though it was earlier considered as a business that was being phased out with advancements in technology.
You might be wondering why everybody is talking about it now?
GameStop is in focus because it was just rescued by the internet from a short-selling technique that hedge funds use to drive down a stock’s price.
Here we will be taking a look at how the GameStop stock gained over 2,000 percent in just a few days.
What is GameStop?
Before we get into explaining, what happened and how Reddit saved GameStop, let us first explain what is GameStop.
GameStop is a large chain of brick-and-mortar retail stores, which specialises in the buying, selling and trading of games and gaming devices. In its initial days, GameStop was the place to go for gamers in the US and multiple other countries where the chain had expanded into. However, in recent years, it has been quite difficult for the company to survive, considering that it has been facing stiff competition from online marketplaces.
Many such brick and mortar stores have already packed up shop, with GameStop being one of the last survivors. Many analysts since 2016, when games started shifting over to the digital distribution model, have compared GameStop to BlockBuster, which was a popular movie rental service in the US, before Netflix and others ate up all of its market share.
Since 2016, the company has been in the headlines for all the wrong reasons, like its Circle of Life policy, Covid-19 response and more. Due to which, its stock has been on a nosedive since.
How did this all start?
Since the company’s stock has been suffering since 2016, it made a huge blimp on screens of well-known hedge funds: Melvin Capital and Citron Research. These firms thought that the stock was overvalued and that there was a chance of going short on it, thus gaining a lot of money in the process. Multiple other firms like Melvin Capital and Citron Research also jumped on the opportunity.
These company’s then started shorting the stock heavily. Thus ending up over shorting the stock more than its overall market cap. After completing the short, these hedge funds were waiting for the stock to fall more, till their stock return promise date closed, even though they had made a lot during the initial short.
However, the news of their short leaked on an online Reddit group, called WallStreetBets. This is when a lot of people started heavily investing in the stock, changing the buy/sell ratio, and thus driving up the price of the stock. Moreover, influential people like Elon Musk, who were also pissed with this technique being used against their companies to bring the cost of their shares down, started tweeting to their massive following to buy GameStop. Musk’ one word tweet: “Gamestonk” skyrocketed GameStop shares. Soon after the tweet, Musk was hailed as an anti-establishment hero.
The reason why Elon Musk and other influential business owners were tweeting in support of the internet is because they have all at some point of time been at the short end of hedge funds. And a company’s market cap is what gets it loans and sanctions, which is destroyed while being shorted.
This made the price of the stock sore, while all the hedge funds on the other side looked at bankruptcy. Basically, the internet short squeezed the hedge funds.
What is Short Selling?
Short selling is a trading strategy that speculates the decline of stock or securities and helps the short seller earn money on it.
Basically in a short sell, a position is opened by a trader by borrowing shares of a stock or other asset, which they believe will decrease in value at a set future date and sold. For this the trader provides the lender with a fee and a promise date as to when they will return the shares. Now near the return date, the trader will book their profits and then purchase the shares at a lower price.
This is quite a risky move as the risk to reward ratio is very high, which is why it is mainly practised by huge investors who can guarantee the downside.
What is a Short Squeeze?
Short Squeeze is one of the markets major weapons against short sellers. It is a technique, which leads to short-sellers hedging their positions or buying the stocks to cover their losses in an event of an adverse price movement.
What is happening now?
Citron Capital, which was aiming to gain around 100 percent returns has already been squeezed and booked a loss of about 100 percent.
Melvin Capital is so far the greatest loser, requiring a $2.75 billion bailout from friends.
Many funds are still holding their shorts hoping that this incident will fade off, bringing down the price. However, the squeezers are also holding on, for fat returns.
Many funds have been introduced into losses even though at a point they were making over a 10,000 percent returns on paper, but kept on holding their positions for higher returns.
Traders calling foul, while the internet backfires
Hedge funds like the above are stating that internet groups like WallStreetBets should be banned as they are not allowing for the market to stay fair. Multiple groups like this on social media platforms have already been suspended by the companies until further notice. The popular trading app, Robinhood has even removed GameStop and multiple such stocks which have recently turned controversial from its market view.
But the internet is not staying quiet, stating that short selling should not be allowed. Many are even claiming that all of these hedge funds are now crying foul after they have been treated the same way in which they have been doing for many years. Elon Musk even tweeted, stating that when you cannot sell a borrowed house, or a borrowed car then why can you sell a borrowed stock.