The stock market and internet are aflame over GameStop, a video game retailer whose share suddenly becomes the darling of day traders who are putting the squeeze on big players of Wall Street.
The stakes are tremendous, with the surge in trading driving the company’s value up by over 10 billion USD as of Wednesday.
Notably, GameStop, the feature of shopping centers and malls across the United States, was worth about 2 billion USD in December last year. Its worth is surged to 24 billion USD, roughly the same as the fuel refiner Valero Energy and the meat giant Tyson, at least on paper (1).
What is Going On?
It is called a short squeeze. It involves investors betting on whether a stock would go up or down. They place the bets by buying the stakes themselves or stock options.
Investors who bet against a stock are called ‘shorts.’ There are at least two big hedge funds are involved in the case of GameStop as shorts.
Shorting a stock means borrowing shares from a broker and selling them. There are agreements that one would return the shares later. When the price drops, one buys back the stocks and pockets the difference. However, it is very risky since if the price rises, one can lose big.
There are times one makes a bad bet. However, one can also lose if someone tries to push up the price by purchasing lots of shares even though the company is not doing anything different.
It is called the squeeze.
Shorts would have to close their position by buying the shares they owe to brokers and return them. The demand kicks off the stocks higher, and if a short wait for too long, it could ruin him.
In the usual case, such standoffs involve sophisticated Wall Street investors (2).
The Rise of GameStop Stock
The amateurs began to drive up the stock price.
Over the last year, armchair traders have risen in the market. After stocks tumbled last year, some recognized the opportunity, while others were trying to scratch a gambling itch after sports leagues were closed; for some, it was only a game trying to scoop dollars instead of points. It was all made easier by the free trades available via platforms such as E-trade (3) and Robinhood (4).
Some of these amateurs are buying GameStop shares, while many are placing their bets against the shorts. It involves contracts that offer them an option to purchase a stock at a certain price in the future. If the price surges, traders can purchase the stock at a bargain and sell it for a profit.
Normally, a small amount of demand doesn’t make much difference to the price. However, if enough traders bet big, the demand can disrupt the stock. If it goes high, the brokers on the hook would have to purchase more shares. Which, in turn, again increases the demand and increases the share’s price.
One can blame the Wall Street Bets forum of Reddit. Wall Street Bets or WSB is one of the weirder places across the internet where armchair traders share memes, along with trade tips and analysis.
The GameStop (5) shares began to rise late in 2020 after the founder of Chewy, a pet-supply online store-bought a stake in the company and got a spot on the board (6).
The company gradually garnered WSP and traders’ attention, frequently visiting Discord, a gamer-friendly social media service.
The motivations of traders vary widely. Some believe that shares of GameStop are a good value, while others are only riding the wave. Some of the traders even want to squeeze Melvin Capital (7), a hedge fund that was shorting GameStop.
However, we also believe that the disruptive tactics against the shorts are not limited to amateurs since big players of Wall Street easily recognize a good opportunity when they see one.
Where it All Started?
Everything started innocently in 2019 with people on message boards exchanging ideas about a left-for-dead mall store chain. However, it has now turned much bigger.
For certain parts of the hedge-fund industry, it has become an existential crisis. A horror story for those old-school investors who believe in discipline and doing their homework before hitting the ‘buy’ button. They are expecting that it would end terribly. Also, a part of the reason why the entire stock market tanked on Wednesday (8).
GameStop Corp. has turned into a national sensation. At first, it is hard to explain how a firm whose sales are expected to drop in the past five years and is likely to announce a third straight loss year has witnessed its price surge to almost 1800% so far in January and 8000% in the past year.
However, it would make more sense if we look at it closely. Warren Buffet’s mantra is to ‘by what you know,’ and it is easy to see why millennial traders, trapped in their homes amid the pandemic could know a thing about gaming.
When they approach the market like a video game with a strategy akin to something that gamers would call a ‘cheat code.’ In this case, they are teaming up and piling into individual stocks how a tight-knit team attacks dragons in ‘World of Warcraft.’
The goal is to force short-sellers and derivative dealers to purchase the share and pump its price beyond anything a conventional investor would consider reasonable (9).
Halting the Rally
GameStop shares have risen 1800% since January 12 as amateur investors from the United States have piled in and forced professional sellers to make heavy losses and abandon their positions.
As online trading portals such as Robinhood markets stopped clients from purchasing the shares on Thursday, it put a halt to GameStop’s rally. Notably, the momentum had earlier pushed the stock above 500 USD (10).
However, after the halt, the earlier rally was erased. The shares dropped as much as 249.73 USD after Robinhood clients reported that they could not trade surging stocks, including GameStop and AMC Entertainment Holdings.
Nevertheless, it is forcing hard questions regarding whether the stock market is a risky bubble. Or if a new generation of traders should take full advantage of all the free trades and tools available on their phones, regardless of how reckless they may seem to outsiders.
Simultaneously, big players of the proletariat are cheering loudly from the sidelines, saying that the move could mean Wall Street, hedge funds, and the 1% are seizing their comeuppance (11).
How We Got Here?
It has been maniacal this month for GameStop’s stock. It was sitting around 18 USD a few weeks ago before doubling up in four days. Even though the stock was down to 229 USD after Thursday, it still up an amazing 1250% through the first few weeks of the new year.
It is worth noting that the company itself is still struggling. The Texas-based retailing firm sells video games at more than 5,000 stores, and the pandemic is keeping its customers away. Another worrisome factor is the long-term customers’ swift towards buying games online, away from brick-and-mortar stores.
Earlier this month, GameStop Corp. had stated that a co-founder of Chewy, an online pet supplies seller, was joining the board. It had to grow enthusiasm among its prospects. Investors see that Ryan Cohen (12) would assist in GameStop’s digital transformation. However, several analysts believe that GameStop would keep losing money even in the next financial year.
There has also been a flavor of the discussion that smaller investors believe in GameStop’s business. However, the frenzy is mostly about inflicting pain on hedge funds, short-sellers, and other big financial firms.
Many are also talking about it as being in the ledger with the financial elite who benefit from years of gains as others fall further behind.
Who Saw This Coming?
There are different ways an investor can make a big profit with small upfront payments if the stock moves in the right direction. Most traders pushing up GameStop are a novice and small-pocket investors.
When they purchase stocks on margin, they use borrowed money to supercharge their profits and losses. With options, investors can purchase the right to buy the stock at a later date at a certain price. If the stock hits the target, investors can make a bigger return. But if it doesn’t, then it can also mean a total loss (13).
There are higher chances that GameStop’s stock would end up at much lower after the frenzy ends. In the long-term, the company’s stock price tends to track with its profit. However, GameStop’s earning prospects are cloudy. Several Wall Street analysts have a price target for GameStop at 15 USD or even below.
It is important to highlight that GameStop is not alone. There are other heavily shorted stocks, which are also witnessing a recent surge in investors’ interest, as they are looking for another GameStop. It includes Blackberry, American Airlines, and other formerly downtrodden shares. These firms also had an extreme swing in their stock prices this week (14).
Notably, the frenzy is also affecting the broader market. Earlier, critics had dismissed the moonshots for GameStop and others as a sideshow. They had stated that the excess was only confined to few market corners.
However, the broad-market tumble on Wednesday gave some caution. The sharp losses of short-sellers had pushed them to sell some of their other holdings to raise cash, and many investors believe that it has contributed to Wednesday’s 2.6% slide for the S&P 500 (15).
Brokerages have been making it easy for novices to get into the trading and market. Commissions have dropped to zero, and now people can also trade from their phones. As each barrier to trading is falling, consumer advocates are cheering on the broadening playing space. However, there were also warnings that it is possible that too-easy trading could encourage people to make too many trades that are very risky for them (16).
However, it seems like no one saw this coming, especially not to this degree.
The Securities and Exchange Commission, SEC (17) had stated that they have noticed the market volatility and are taking a look. It is their job to protect investors, and the expectation across Wall Street is that investors holding shares of GameStop at these prices are likely to be hurt when the prices would drop.
What is setting the whole GameStop insanity apart is the entire communication between investors is happening on Reddit. According to Chester Spatt, a former SEC chief economist and a finance professor at Tepper School of Business, Carnegie Mellon University, they are going after each other to kick the stock prices higher.
He added that it is difficult to declare the scenario as a clear case of market manipulation. Because in the end, there may be no way to prevent traders from pushing a stock too high and potentially burning themselves. Instead, it is better to properly educate novice investors about the overzealous trading and risk of bubbles.
The Standoff and Paradigm Shift
There has been a rollercoaster in the GameStop’s stock price with a horde of Wall Street Bets subreddit investors in a standoff against short-sellers and massive hedge funds.
Notably, GameStop, trading as GME on Wall Street, has been shorted massively. It means that investors, most of them being backed by big financial institutes, have been betting on GameStop’s stock going down. More stocks have been short sold than they exist. Now, short-sellers would have to ‘cover’ the stocks at some point.
They would have to purchase the stock, leading to a short squeeze where an increased buying flurry among both short-sellers and normal investors drives the price up.
What is happening with GameStop’s stock is called a melt-up. It is similar to a meltdown, which we understand as a sudden and chaotic system breakdown, but in the opposite direction. In this case, the price goes vertical, mostly because of a speculative frenzy.
While the Wall Street Bets’ investors tell their followers to hold the line, the stock fluctuations prove that some of them are cashing their shares. It makes sense since people who bought the GameStop stock early pocketed the shares for about four USD each. Once it hit 100 USD, selling these shares becomes an attractive option (18).
It is like the market is witnessing a paradigm shift. It is the Wall Street Bets people who have ganged up to center on a few stocks. We are most likely to see the paradigm with Bed Bath & Beyond through a loop upgrade. We are also seeing the same for AMC, stated Jim Cramer, a CNBC Wall Street pundit (19).
It is not something we have seen before since they have managed to break shorts. As time goes on, we can see clearly that the stock market is completely unattached from reality.
Can a Bid Like This Happen in India?
Stories are emerging out of Wall Street about retail traders becoming multi-millionaires in a matter of weeks by buying and holding shares of micro-cap companies such as AMC Entertainment, GameStop, and BlackBerry to trigger a short squeeze by big institutional investors. It has turned heads all across the globe.
GameStop’s story has become the centerpiece of global financial space after a few retail traders discovered that if they buy and hold a stock with heavy short positions, the short-sellers would have to run from pillar to post to cover their positions. Consequently, there was an enormous short-squeeze which even Wall Street has never seen.
In India also there are several internet forums on Telegram, Reddit, Discord, and WhatsApp. They are filled with retail traders who are now aiming to replicate the same on the other side of the world.
In one such forum called Indian Street Bets, a Reddit group with about 12,000 members, one of the hottest topics is sending Suzlon Energy shares to the moon by kicking off its prices through coordinated purchases.
However, according to market watchers (20), any attempt to trigger the short squeeze in the Indian market is futile. It is mainly because no one in the country holds such huge short positions in an individual stock, especially when it is not part of the derivatives segment.
Shorting a stock is a tedious activity in India because of the several regulatory restrictions put into place by the SEBI, Securities and Exchange Board of India. One can also say that short selling is a frowned-upon practice in the country.
Traders can short a stock, but they can’t hold the position for more than one trading session. They would have to compulsory reverse it at the end of the day. Most traders and institutes in India restrict their short positions to stocks in the derivative segment to get around the hurdle. However, only 140 stocks out of over 2,000 listed stocks are traded on the NSE, National Stock Exchange.
Even in the segment, traders need to pay a high price for holding short positions. It means a trader needs to pay a fee in the form of rollover costs to carry the position if he intends to hold it for a longer-term.
Traders are guaranteed leverage and liquidity, which can become a foe or friend depending on which side of the trade one is. In the SLB segment, liquidity is usually missing, especially as one goes down the market capitalization ladder.
But even in the F&O segment, the violent moves witnessed in GameStop and AMC stocks are not easy to replicate in India. SEBI has placed market position-wide limits and individual position-wise limits to make sure such aberrations are not repetitive.
So, the members of Indian Street Bets, who are looking to create a GameStop like phenomenon in the country through Suzlon Energy, the bad news is that it is quite difficult and nearly impossible when the stock is not listed in the F&O segment.
Buying and holding for long-term value creation is the only way to create the kind of wealth that retail investors in the United States have amassed to become the world’s envy in India. However, purchasing and holding strategy need patience and time. Both of them are in short supply when it comes to a liquidity-driven bull market in India like the present one.