In the recent weeks, you might have read about GameStop’s phenomenal price rally and wild swings in-between – reaching $480+, up almost 2500% from the start of the year when it traded at just $18+.
So, what’s going on there?
A little backstory
Hedge funds – funds that pool money an employ a variety of strategies for returns – were shorting GameStop’s stock for a long period of time.
When you short a stock, you are actually borrowing someone’s shares to sell, in the hope that the price will fall, you buy back at a cheaper price and you pocket the difference.
Short sellers have to eventually buy back the borrowed shares, which puts the risk of downside almost unlimited because the price of the stock can technically go to infinity, and the short sellers must cover their positions by buying back the stock at whatever price.
Some retail traders saw GameStop’s high short interest (even more than 140% of shares available at some point) that they decided to tell everyone publicly about this using Reddit’s WallStreetBets subreddit to coordinate their stock buys and push GameStock’s price up.
A couple of aggravating scenarios were at play that made the stock price rise extremely quickly over a short period of time.
The first was a short squeeze – as many small retail investors moved together to push the price of GameStop higher, the investors who were short would have to buy the stocks to limit their losses – this caused the price to push even higher.
The second is a gamma squeeze – where dealers who sold deep out-of-the-money call options on GameStop’s stock to traders for cheap, had to hedge their exposure as well by buying the stock. This caused the price to rocket even higher.
The short and gamma squeezes lead to a self-sustaining rocketing price, and when coupled with enthusiastic retail investors who want to bring down hedge funds who got away “scot free” after screwing everyone except themselves during the 2008 financial crisis, extensive media coverage about this phenomenon and the explosion of free commission trading apps globally, you get this crazy rocket pump on the stock.
How will this end is anyone’s guess, but some retail brokerages like Robinhood and TD Ameritrade have responded by restricting buys on Gamestock, allowing only sell orders to go through, which led to even more hatred from the online community and many even threatening to pursue a class action suit against them for market manipulation.
With the rally sending the GameStop’s price to the stratosphere, seemingly endless media attention on the stock, and WallStreetBets’ rocket emojis and memes, it’s a game of chicken before the game stops.