A Historic Short Squeeze – The Story of GameStop

If you have been paying attention to the news recently, there is a large chance you have heard of the recent spike in GameStop’s stock value. In this article, I’ll break down what happened to GameStop and why this short squeeze is a big step not only for the market, but mankind.

Over the past week, we have been witnessing history within the stock market. GameStop (ticker symbol GME), which almost went bankrupt in early 2020, has reached record highs with a market value shy of $24 billion in the past week. It’s even possible that many of you have taken part in the GameStop short squeeze (defined below) or have been following it very closely. The short squeeze was mainly driven by an online social news and discussion page called Reddit, similar to 知乎 in China. In an unprecedented turn of events, Reddit day traders have successfully sent the stock to the moon by more than 1,500% in this year alone. In turn, short-sellers (bolded words defined at the end) have lost nearly $19 billion on GameStop just in 2021. To the surprise of many economists globally, retail investors have made the start of 2021 more bullish than ever imagined.

To many investors, the WallStreetBets (WSB) has become a household name, synonymous with the GME short squeeze this year. WSB is the Reddit forum that introduced the idea of the GME short squeeze by realizing that GME’s short interest was close to 140%. To understand what a short squeeze is, one must first understand the concept of shorting. When a company, hedge fund, or individual investor shorts a stock, they essentially believe that the share value will drop in the future. In order to short a stock, the investor must borrow shares from a lender, then sell the shares (because they believe in the imminent future, the price per share will be lower in value), rebuy the shares at a lower price, and finally return the initial shares back to the lender while keeping the difference. So, because GME’s short interest was so high, this meant that many hedge funds were keen on shorting GME. This is a very simplified breakdown of shorting, but it will come in handy when we discuss the GME short squeeze.

According to NYU Stern Professor of Finance, Aswath Damodaran, he claims that the historical events of this past week should be termed a “Crowd Squeeze”. The WallStreetBets forum on Reddit had a few very smart investors who realized that the GME short squeeze was bound to happen so long as a revolution could take place among retail investors. Let’s break down what a short squeeze is using a very simple and fun analogy: imagine that five bananas currently cost $10. One monkey on the market has five very nice, yellow bananas. A giraffe comes along and asks to borrow the five bananas for a short period of time. While the bananas are in the giraffe’s possession the giraffe decides to sell the five bananas thinking that the price of the bananas will go down (shorting the bananas). The giraffe thinks that it will buy them later for cheaper and then return them to the monkey, therefore profiting from the difference. Yet, all of the smart, determined monkeys realize what the giraffe was doing, so the monkeys decide to buy all of the bananas on the market until the giraffe has no other choice than to buy the bananas from the monkeys in order to return what they had borrowed. The revolution only occurs when the group of monkeys stay loyal and determined to not sell their bananas (similar to holding shares), then the price will go up.

In this example, the retail investors are the monkeys and the hedge funds are the giraffes, and if the price of GME and other heavily-shorted  companies like AMC (movies/entertainment), NAKD (fashion), and BB (phones, technology) continue to rise, then the hedge funds will pay a significant amount of interest on these stocks which will force them to buy back more of their initially shorted stock. If retail investors and people that have short positions continue to buy the stocks, what will end up happening is known as a short squeeze – an exponential increase in the price of shares in GME and others.

Yet there is something more historical about this short squeeze – it represents a current surge in retail investors and a new group of investors coming from social media, specifically Reddit. At this point in time, the fundamental, technical, and quantitative analysis that you may have learned in your finance class merits no reward; everyone is on an equal playing field. Since the short squeeze, GameStop has not officially made a public statement, so if you want to understand the movement and volatility of these stocks you must first understand the group sentiment of retail investors through various online platforms. But be careful: everyone is a genius in a bull market. Who knows, maybe in the not too distant future we will all be watching a movie called “Crowd Squeeze” in theaters.

Glossary

Short-sellers: investors who are betting that a stock will go down in value

Bull Market: the condition in which prices in the financial market are rising and expected to continue rising

This article was written by Grant Kind currently based in Shanghai, China. Please send an email to gak336@nyu.edu to get in touch.

Photo Credithttps://www.ft.com/content/47e3eaad-e087-4250-97fd-e428bac4b5e9

One thought on “A Historic Short Squeeze – The Story of GameStop

  1. Despite Musk’s wins, the shorts haven’t budged much, Tesla continues to be the most shorted stock in terms of the value of short positions. The rally in Tesla shares, experts say, is not so much because shorts are covering, but because of large amounts of buying in out-of-the-money options, where premiums are low. With such trades, option writers hedge their position by buying a certain quantity of the underlying stock, pushing up prices partly as a result. Then, there was the the whole Robinhood phenomenon which drove up some popular stocks such as Tesla. All of this led a so-called gamma squeeze, requiring option writers to buy a greater quantity of the underlying stock to hedge the position adequately. The apes, too, have built up large positions in GameStop using call options, and the gamma squeeze strategy appears to have worked to an extent as well. Of course, with the same logic, corrections can be equally sharp and severe when the price trend reverses, and option writers cut positions, alongside others looking to exit.

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