Article by Andrew Culver, PGDL student at BPP
Gaming retailer GameStop’s share price (NYSE: GME) rocketed up from $43 to $371 per share over a 50-hour period.
The NYSE stopped trading for GME stock nine times, but despite this, small investors continued to drive the price higher.
Hedge funds collectively lost over $5 billion in shorts, while individual home investors made considerable gains.
Why did this happen?
The shift towards online shopping has hit physical retailers like GameStop hard. In April, the company announced plans to close 450 shops, sending the share price from $8.50 to $3.25 per share.
Ryan Cohen and two associates were added to GameStop’s board in January and began encouraging the company to move its business online to compete with Amazon. The company’s share price rose, but hedge funds were sceptical about GameStop’s chances of success.
This highlighted a fundamental difference in strategies in the investing world. Small traders took advantage of zero commission brokers like Trading212 and Robinhood to buy GME, looking to make quick profit from a cheap, but rising stock.
However, institutional investors, most notably Melvin Capital, bet against GameStop by ‘short-selling’ its stock; 84% of all GME stock was held in short in April 2020. This risky strategy involves borrowing a stock, selling it, then buying it back to return it to the lender. This is a bet that the share price will fall, leading to profit as the investor buys back the stock for less than they paid for it. However, if the share price does not fall, the investor stands to make significant losses; there no limit on potential losses when short-selling because the share price can rise indefinitely.
The wallstreetbets subreddit, a collection of individual traders on the social media site Reddit, decided to collectively pile onto GME to raise the share price and inflict substantial losses on short-sellers. They called this tactic the ‘short squeeze’ and have pitched the move as ‘a battle between regular people and Wall Street’. The short squeeze is novel because large numbers of coordinated small traders have a combined purchasing power that eclipses that of institutional investors. This coordination has likely been made possible by the ever-increasing significance of online communication and the global push towards working online during the COVID-19 pandemic.
On Tuesday, GME slowly rose in preparation for Friday’s short squeeze until Elon Musk, the billionaire entrepreneur behind PayPal, SpaceX and Tesla tweeted out ‘Gamestonk!!’ after the NYSE had closed for the evening (https://twitter.com/elonmusk/status/1354174279894642703). News outlets and larger investors began to notice, and GameStop’s stock explosion became mainstream knowledge. Pre-market speculation raised GME from its closing price of $147.98 to $298.90 per share when the market opened on Wednesday.
Zero commission brokers and popular providers of stock market data like MarketWatch crashed under the strain of GME trading. Nearly 200 million GME shares changed hands on Monday and Tuesday (while the company has 69.75 million total), and 68 million have been traded so far on Wednesday. At its peak, GME hit $371, but has since fallen to ~$325 at the time of writing.
Some people benefitted from GME’s surge. For example, Reddit user /u/Stammbomb increased his by $64,000 and made a post about using the money to put his sister through treatment for Lyme Disease. Some have hailed this as an example of regular people playing the system and winning.
However, the past few days have shaken institutional investors. According to data analytics company S3 Partners, hedge funds which tried to short GameStop have collectively lost more than $5 billion in 2021 (https://www.shortsight.com/gamestop-shorts-down-5-billion-in-2021/). Hedge fund manager Michael Burry warned that the situation was “unnatural, insane, and dangerous”, having previously made a 15x return on his own fund’s investment in GME.
CNBC, an American business news channel, have called for regulation. Whether GME’s surge will lead to regulation targeted at preventing market manipulation is not yet known, but the calls are growing. While CNBC’s calls for regulation are aimed at the USA, where GME is based, traders who bought GME came from all across the globe. GME’s surge opens important questions about the legality of coordinated international dealing and whether or not it constitutes market manipulation.
In the UK, there are strict laws surrounding market manipulation. Relevant here are Part 7 of the Financial Services Act 2012 (which makes market manipulating statements an offence) and the Criminal Justice Act 1993 (which deals with the offence of insider dealing). It is yet to be seen how a legal case against so many individual traders would be possible, leaving lawmakers with the difficult task of preventing something like this happening again before more institutions are forced into huge losses. Yesterday, Melvin Capital was bailed out for $2.75 billion by Steve Cohen’s Point72 and Ken Griffin’s Citadel.
Furthermore, CNBC reported that Melvin Capital had closed their short position, taking the losses. However, there has been some debate about whether CNBC’s reporting was accurate. Data published by S3 Partners this morning showed that the short interest was still very high, suggesting that Melvin Capital had not yet closed their whole position. This adds a layer of complexity to the question of market manipulation in the GME surge.
Reddit traders have diversified and turned their attention to various other struggling companies such as AMC (a cinema chain) and BB (Blackberry). Meanwhile, the SEC issued a statement saying they were investigating market volatility and the wallstreetbets subreddit went private, citing moderation difficulties.
(photograph: nicolasmccomber/getty images)