Published in El Pais, 6 February 2021.
All over the news people are talking about the surging GameStop price. In September one share was valued at roughly $4, today it is trading at over $470. So, what happened and is it too late to get in on this?
Key Terms: Before I go further into detail, I will define a few key terms needed to understand the story (feel free to skip this part if you already know what they are).
GameStop: An American videogame retailer that mostly relies on brick-and-mortar sales.
Shorting a Stock (Short): When someone expects the price of the stock to go down you can borrow a stock with interest, sell the stock to someone else, then when the price goes down, by the stock back and return it to the original owner with interest. For example, I can borrow stock “X” valued at $100 at 5% interest and sell it to someone else for $100. In one year, the price goes down to $50, I buy the stock and return the stock with the $5 interest, making a $45. It is possible for there to be more shorts than there are stocks. Remember this for later.
Reddit: A social media platform where organizations covering all sorts of topics from painting to stock advice get together virtually to discuss their topic of interest.
Short squeeze: When those who own shorts desperately buy stocks of the company to try and pay back their debts.
Ok now on to the story.
A Perfect Storm
With video game sales moving to online where you can instantly get your game downloaded to your PC and console, GameStop was having trouble competing, with the pandemic making people leave only for essentials, buying and downloading a game right from your living room became even more appealing. Many hedge fund managers saw the writing on the wall and shorted the stocks.
In August however a company called Chewy starting buying their shares, with the company having senior executives with lots of experience in online retail, a direction GameStop needed to go to ensure its survival, the stock started to creep up. By December Chewy had a 13% ownership stake in the company.
Those who shorted the stock started to take notice and realized there could be trouble, to combat this they bought even more shorts in the hopes of artificially deflating the price as they could be a lot of money if this trend were to continue.
Now remember when I said it is possible to short more stocks than there are available? Eventually there were 71 million shorts for GameStop that only have 69 million shares available, combine that with many shares being held in the company (where do to insider trading regulations make it difficult to sell) and many others being held by investing funds that do not sell shares very often, it was estimate that there were only 20 million shares available for purchase, against a debt of 71 million shorts. One Reddit group that was dedicated to investing noticed this and encouraged its members to purchase as many shares as possible and hold on to them to make even less shares available to those that shorted. When these hedge fund managers saw what was happening, they too try to buy as many shares as they could to prevent their losses so they can pay back their debts resulting in a short squeeze. The demand was huge and the supply non existent as many were forced to buy the stock back at whatever price it was available to them and the hedge funds lost billions.
Is the short squeeze over? Today the stock plummeted 20% so maybe so the time to buy the stock might be over. Will this ever happen again? Maybe but it is likely many will learn from this mistake and prevent them from being in such a vulnerable position again. Shorting stocks has always been risky and I have talked to experience traders before this happened who say they never short stocks. The practice itself is often seen as controversial as unlike investing, shorting stocks does not help companies grow so I can see many traders and hedge fund managers having more strict protocols in place before a stock can be shorted, if they allow it at all. So if you want to watch out for the next big short squeeze you may be waiting awhile.