I’m sure you’ve all heard of the GameStop saga that rocked the financial world, but do you know what actually happened and why? In this post, I’ll try to explain the basics of the GameStop short squeeze and its impact on the market and the society.
What is a short squeeze?
A short squeeze is a situation where a large number of investors who have bet against a stock (called short sellers) are forced to buy back the shares at a higher price to cover their losses, which in turn drives the price even higher. This creates a positive feedback loop that can result in huge price spikes.
Why did GameStop become a target for short sellers?
GameStop is a video game retailer that operates mostly in physical stores. The company has been struggling for years due to the decline of mall traffic and the rise of online gaming. Many hedge funds and other institutional investors believed that GameStop was doomed to fail and decided to short sell its stock, meaning that they borrowed shares from other investors and sold them, hoping to buy them back later at a lower price and pocket the difference.
By late 2020, GameStop had one of the highest short interest ratios in the market, meaning that a large percentage of its available shares were sold short. According to some sources, more than 100% of GameStop’s public float (the number of shares that are actually available for trading) was sold short, which is theoretically impossible unless some shares are borrowed and sold multiple times.
How did Reddit’s r/wallstreetbets trigger the short squeeze?
r/wallstreetbets is an online community on Reddit where users discuss high-risk, high-reward trading strategies, often involving options and leverage. The subreddit has a culture of memes, jokes, and irreverence, and is known for its disdain for hedge funds and Wall Street elites.
In late 2020, some users on r/wallstreetbets noticed that GameStop was heavily shorted and saw an opportunity to profit from a potential short squeeze. They started buying shares and call options (contracts that give the right to buy shares at a certain price) of GameStop, hoping to drive up the price and force the short sellers to cover their positions. They also encouraged other users to join them, using slogans like “to the moon” and “diamond hands” to express their optimism and determination.
The movement gained momentum in January 2021, as more and more retail investors joined the frenzy, using platforms like Robinhood, which offer commission-free trading and easy access to options. The demand for GameStop shares exceeded the supply, causing the price to skyrocket from around $17 at the beginning of the month to over $500 at its peak on January 281. This created a massive loss for the short sellers, who had to buy back the shares at inflated prices or face margin calls (demands for additional collateral) from their brokers.
What was the impact of the short squeeze?
The GameStop short squeeze had significant consequences for various entities involved or affected by it. Here are some of them:
Losses by short sellers: According to some estimates, short sellers lost more than $19 billion on GameStop in January2. Some hedge funds, such as Melvin Capital and Citron Research, suffered huge losses and had to receive bailouts from other investors.
Companies with increased stock value: GameStop was not the only company that saw its stock price surge due to the r/wallstreetbets phenomenon. Other companies that were heavily shorted or had a cult following among retail investors, such as AMC Entertainment, BlackBerry, Nokia, Koss, and Bed Bath & Beyond, also experienced significant price increases4.
Gains by existing shareholders and third parties: Some existing shareholders of GameStop and other companies benefited from the price spike, such as Ryan Cohen, the co-founder of Chewy who joined GameStop’s board in January and saw his stake increase by more than $2 billion
Some third parties also profited from the situation, such as Elon Musk, who tweeted “Gamestonk!!” with a link to r/wallstreetbets on January 26, boosting his own net worth by $180 million as Tesla shares rose.
Losses by retail investors: Not all retail investors who participated in the GameStop frenzy made money. Many of them bought shares or options at high prices and saw their value plummet as the price dropped in February. Some of them also faced restrictions or delays from their brokers, such as Robinhood, which temporarily halted trading or limited buying of certain stocks due to liquidity issues.
What was the aftermath of the short squeeze?
The GameStop saga sparked a lot of controversy and debate among various stakeholders, such as regulators, lawmakers, media outlets, academics, and celebrities. Some of the issues that emerged from the event include:
Investigations: The Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Department of Justice (DOJ), and several state attorneys general launched investigations into the trading activity and the role of brokers, hedge funds, and social media platforms in the GameStop episode. The SEC also issued a statement warning investors of the risks and volatility involved in trading certain stocks.
Congressional hearing: On February 18, the House Committee on Financial Services held a hearing titled “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide”, where they questioned several witnesses, including the CEOs of Robinhood, Citadel, Melvin Capital, Reddit, and a r/wallstreetbets user known as Roaring Kitty. The hearing covered topics such as market manipulation, payment for order flow, gamification of trading, financial literacy, and systemic risk.
Lawsuits: Several class-action lawsuits were filed against Robinhood and other brokers by retail investors who claimed that they were harmed by the trading restrictions or glitches during the GameStop frenzy. Some lawsuits also targeted hedge funds, such as Melvin Capital and Citadel, for allegedly conspiring to manipulate the market or pressure brokers to limit trading.
Regulation: The GameStop episode raised questions about the need for more regulation or reform of the financial system, such as imposing limits on short selling, increasing transparency of short interest data, enhancing oversight of brokers and hedge funds, protecting retail investors from predatory practices, and addressing conflicts of interest in payment for order flow.
Reactions: The GameStop saga elicited various reactions from political figures, public figures, retaliation and protests, alleged conflict of interest between Robinhood and Citadel, internal communications revealed, and media adaptations. Some of them are:
Political figures: The GameStop event attracted bipartisan attention from politicians who expressed their views or concerns on the matter. Some of them supported the retail investors and criticized the hedge funds or the brokers, such as Senators Bernie Sanders, Elizabeth Warren, Ted Cruz, and Josh Hawley. Others called for more regulation or investigation of the market activity, such as Senators Sherrod Brown, Pat Toomey, and Cynthia Lummis.
Public figures: The GameStop phenomenon also drew comments from various celebrities and influencers who shared their opinions or experiences on social media or other platforms. Some of them praised or joined the r/wallstreetbets movement, such as Elon Musk, Mark Cuban, Chamath Palihapitiya, Ja Rule, Jon Stewart, and Snoop Dogg. Others warned or advised the retail investors about the risks or opportunities involved in trading certain stocks, such as Warren Buffett, Jim Cramer, Dave Portnoy, Kevin O’Leary, and Ashton Kutcher.
Retaliation and protests: The GameStop episode sparked some backlash and resistance from some groups or individuals who felt aggrieved or outraged by the actions or decisions of certain entities. For example, some r/wallstreetbets users launched a campaign to send physical letters to the SEC to complain about market manipulation by hedge funds. Some Robinhood users vandalized or protested outside the company’s headquarters or offices to express their anger over the trading restrictions. Some hackers also targeted Robinhood’s website and app with cyberattacks or leaked its customer data online.
Alleged conflict of interest between Robinhood and Citadel: One of the controversies that emerged from the GameStop saga was the alleged conflict of interest between Robinhood and Citadel Securities. Citadel Securities is one of the largest market makers in the US that executes trades for retail brokers like Robinhood. Robinhood receives a portion of its revenue from payment for order flow (PFOF), which is a practice where brokers sell their customers’ orders to market makers like Citadel Securities in exchange for a fee. Citadel Securities also provided a $2 billion bailout to Melvin Capital, one of the hedge funds that suffered huge losses from shorting GameStop.
Personal opinion: The practices implemented by these institutions caused a chain reaction that fueled a media frenzy. In other words, when the boss fucks up, you can bet he'll cover his ass. Well, if you can't really defend the action or information against you, the next step is to discredit the source, in this case, a few people who saw what a billion dollar firms missed. Try explaining that one to the man in charge. Try to defend a six or seven figure salary when a kid on a computer can do exactly what their paying you for, only better.
Thank you for taking the time to read this,
This article was put together with the help of chatgpt at the direction of myself (Nick - Yolo to the Moon)
Words of wisdom - Save time, not money 🚀✨️
Image - The derpy astronaut