The Legendary Saga of GME (Gamestop) Frenzy
Updated: Mar 4, 2021
What a thrilling week it has been with all of the hype around the story of how the small guys are taking on the big guys in Wall Street. Some even predict that this is only the beginning and there are certainly going to come big changes after change in the realm of the free market. In a sense this was testing the conditions of our current market and to see how truly free our market is. It is fascinating to dissect this story in different angles and I wanted to help those people out who would like to get a better understanding of what has happened. So feel free to read on my rendition of explaining what has happened and why this story is so significant to understand.
In the days of high speed internet and ever increasing computing power of our technologies, the free market of Wall Street has seen various events that were incredibly tumultuous but has proven that it can still stand firm with the test of time. This yet again was another one of those events that will have rippling effects into various segments of Wall Street operations and conditions for years to come. For those of you who do not fully grasp what has happened in the last several days, I want to help you simplify and understand the controversy surrounding this event.
The key players in the stories include, numerous hedge funds who bet on shorting of GME stocks, but most notably include Melvin Capital who reportedly lost more than 50% of its short position, the now infamous Reddit channel wallstreetbets whose day trading members came together in an extraordinary unity of sharing strategies to profit from these overly compensated short position bets placed by hedge funds through implementing an unprecedented magnitude of short squeezes. Last but not least, the brokerage under intense scrutiny with a class action lawsuit, the trading platform app Robinhood.
Now, those are the most important key players and terms to understand about this whole frenzy. So, what is a short position and what is a short squeeze? Also, what is the alleged market manipulation that became so controversial and is now under siege by enormous amount of media attentions? First we have to understand the role and the functions of a hedge fund. In a layman's term, hedge fund is a money manager for investors who possess large quantity of assets. We are talking multi millions and billions worth of assets under management. Now, because of the trading volume and the sizes of these positions being taken by hedge funds, they tend to make a strong macro level impact on the bets they make. Generally, normal day to swing traders have no chance of taking advantage of the positions taken by these institutional investors. Rather in retrospect they find themselves defending against their moves as it can dictate the trend of a stocks value. However, now with the power of an online community and the speed of information that can be transferred through the web, we are witnessing a community that are able to fight against the size and the magnitude of the moves that the institutional investors are making. This whole episode of GME saga has been a testament to the old saying of "United we stand, divided we fall".
So what is the meaning of a short position or the option of shorting a stock. For those of you who don't understand what margin trading is, it's basically being able to obtain a loan on shares of a stock from the brokerage and either using it to bet on stock prices going up or down. After placing these position with loaned amounts of shares, you simply pay the loaned shares back to the brokerage plus any interests that may have accrued from the loan later after closing this position. Likewise, when you are shorting a stock you are borrowing the stocks from the brokerage, selling it when the price is high then, when the price drops buying back the shares at a lower price then returning back the stocks thus realizing the profit in the difference of the price fall. Let's say you borrowed some shares of the stocks when it was $2,000 so you sell it then, the price drops to $1,000 and you buy back the share at $1,000 and return back the shares to the lender, thus pocketing the profit of $1,000 ($2,000 - $1,000) in the short sell. This obviously is a very lucrative deal, since the price of the stock can drop significantly and one could definitely earn a sizable profit, however it is also very risky because in reality the stock could end up going up in value and theoretically it could go up indefinitely. So the amount of loss you can realize far outweighs the realizable profit. However, if these techniques are used in a strategic manner it can be an incredible tool for the traders by using it in conjunction with strategies to mitigate the risks.
Another key point we need to understand is the simple rule of supply and demand and how the stock prices rise and fall. Simply put the stock price goes up if there are more people willing to buy the stocks and the price falls when there are more people wanting to sell the stocks. So this was the case of the GME stocks. When institutional investors like a hedge fund decides to bet on the downturn of a company it starts borrowing large quantity of shares then short selling all of these stocks. I remember hearing from some media source that the hedge funds were shorting these stocks at float of a 120%. Now, obviously the price of the stocks will drop when these big players are shorting the stocks thus buying back the stock when the price falls. It almost feels like it's a rigged game, but that's just how things are in the world of this free market. The big hands tend to control the flows of stock prices to their advantage. However, this is where the interesting thing happens. The members of the now the infamous reddit channel wallstreetbets saw that there was an opportunity to be made, if they are able to unite and work together to squeeze the position of these overly shorted shares of GME. Think about it, these hedge funds have to buy back the shares at some given point and return the shares back to the lender. If they hold on to it more than the profit they can realize, the interest on these shares will put them at a loss, or if the price of the stock goes higher than when they initially shorted (sold) the stocks then now they have to buy it back at a higher price which would put them at a loss. They would find themselves in a huge dilemma and that's why the timing of executing these decisions need to be so impeccable, otherwise you can find yourself with an incredible amount of loss or even at the point of ruin for your investments. The whole mantra behind this community of day traders at wallstreetbets is to fight with the institutional investors by rallying together to create a force just as big as what these institutional investors could create. The idea seems incredibly plausible, but in reality it's easier said then done; until now. It was truly mind blowing how united these day traders came together on identifying the overly shorted position of GME and executing a squeeze so swiftly and gracefully that it put the institutional investors at a serious bind. These traders decided to stock up on GME shares together understanding if more of them start buying these nearly bankrupting shares, the prices will start to rise. If they do it at a scale big enough it will rise significantly. That's what happened with GME stocks, it soar through the roof, trading around $17.25 on January 4th, 2021 and rising up to $347.51 on January 27, 2021. (1,914.55% increase) That is an incredible achievement of these community of redditors to rally up that much momentum (biggest jump from the 26th to 27th, $147.98/share to $347.51/share in a day!) in such a short period of time that it left a large number of hedge funds to be in an extremely tight squeeze (either buy back the shares now and realize the losses at current price, or hold onto it longer wishing the price of the stock to go down with the risk of the interests on these short stocks to rise exponentially in parallel). As long as these redditors/traders hold their asking price high and not selling the shares at the current minimum bidding price, the prices of the shares will keep on soaring. On the other hand, the hedge funds with short positions are at a huge loss needing to buy back these share at a lowest possible price in order to minimize their losses. But the jump in the stock prices are so extreme, I doubt any short position can come out of this situation without a huge scar.
Finally, here's the last twist in the mix. When this frenzy of soaring stock price of GME was in procession, a well known trading platform Robinhood allegedly made an interesting move that sought the scrutiny of many. It was reported that the ability for none institutional owners to freely trade was taken away and it was reported that the platform was only allowing the stocks to be sold and not bought anymore. Thus, stopping the rise of the share price and which is mind boggling to understand how and why was this restriction came into place and what are the justification for this alleged manipulation of the market that seems to help the short positions to mitigate the risk of additional losses. No one truly knows what this debacle is about and if the allegation is held to be true, then it would be very interesting to find out what would be the consequences for the future of this platform and/or other uncovering of market manipulation arising from this event. I guess we'll have to sit tight and wait to hear more information on the class action lawsuit that was filed against the company.
Well, there you have it. I hope this helped some readers to understand the whole fiasco better, and hope that it in anyway helped encourage someone to be motivated to uncover this story more in depth as we live through yet another historical day in the Wall Street timeline. If you found this article to be interesting and would like to continue to hear more of our stories in the future, please visit regalunited.com and subscribe to our mailing list and we'd love to connect with you. If you are also interested in learning more about building technology for cryptocurrency trading, algorithm based trading and or other fintech related solutions, please visit iiinigence.com and connect today to explore your options on building a modern automated, integrated trading solutions. Thanks and until we meet next time.
Founder/Principal at Regal United