AnalysisU.S.

GameStop short squeeze: 5 things to know as we reach the endgame

By now you must have heard of GameStop and how a Reddit forum of stock and option traders on r/wallstreetbets have been massively buying up shares of GameStop in a bid to prevent Wall Street hedge funds from running the video game retailer into the ground and profiting from their short trades. Year to date, the share price of GameStop has risen from US$17.25 to US$325.00 (as of 31 January 2021).

I won’t dive into the full details of what a short trade is – there are already many articles/videos explaining it – but I will give a quick summary of the GameStop situation and what the endgame is for all the ‘retards’ (anagram of traders) on r/wallstreetbets and everyone else on their side.

In a nutshell, a bunch of Wall Street hedge funds — chief among them, Melvin Capital and Citron — have bet billions that GameStop will ultimately go bankrupt as video game retailing goes digital (similar to what happened with video rentals and Blockbuster). However, in their greed, the hedge funds shorted up to 140%(!) of the public float of GameStop stock. (Just to give you an idea, a short interest of 20% is considered extremely high.) What this means is that the hedge funds short sold more shares than there are actual shares available on the market. This isn’t meant to happen and is illegal. But evidently, no one was paying any attention or enforcing this rule.

Eventually, r/wallstreetbets picked up on this (all hail our king u/deepfuckingvalue) and decided to take the opposite trade and buy up shares of GameStop in order to drive the price up and trigger a short squeeze. As prices go higher, short sellers lose more money which eventually forces some of them to close their position by buying back shares. As short sellers buy back shares, this pushes the share price even higher, forcing even more short sellers to close their positions or risk losing more money. This causes a chain reaction as more and more short sellers close their positions as prices rocket upwards.

The mother of all short squeezes

Short squeezes are not uncommon and the ‘mother of all short squeezes’ happened in October 2008 when Volkswagen briefly become the most valuable company in the world when Porsche increased its stake in Volkswagen which suddenly reduced the available float to a level far below the short interest. Volkswagen’s share price spiked from €210 just before the squeeze to as high as €1,000 intraday before settling around €300-€400 as the shorts eventually exited the market. The hedge funds who bet against Volkswagen collectively lost US$30 billion.

This is r/wallstreetbet’s endgame.

As long as everyone continues to buy and hold GameStop — thereby pushing prices up and reducing the available float — the short sellers will cave in eventually.

You may ask why short sellers can’t wait indefinitely for share prices to fall before closing their positions. Firstly, short sellers have to pay interest to borrow shares to short sell. So the longer this drags on, the more the hedge funds bleed money. Secondly, if prices rise too high, brokers will typically trigger a margin call to close the short positions before the losses balloon to astronomical levels. Because if a hedge fund goes bankrupt, their broker becomes liable for the losses.

However, despite its stock price rising 1,630% since the start of the year, GameStop’s short interest currently remains at 113.31% according to estimates by S3 Partners; the shorts have yet to close their positions. In other words, the squeeze has not been squoze.

Main Street vs. Wall Street

Occupy Wall Street in 2011.

What started out as a short squeeze trade on an Internet forum has since morphed into a political movement and a wider class conflict between the average American investor (now joined by other people from around the world) and the Wall Street bankers and billionaires who set off the Global Financial Crisis due to their greed and avarice.

Back in 2008, hedge funds like Lehman Brothers and Bear Stearns crashed the global economy which caused millions of people to lose their jobs, homes, and families (due to depression, alcoholism, and suicides). However, instead of paying the price, the Wall Street bankers were bailed out by the U.S. government and only one was put in jail for their role in the worst economic crisis since 1929.

Since they were bailed out the last time, it is not much of a surprise that Wall Street is still driven to take excessive risk in search of profit. In the case of GameStop, hedge funds illegally sold short up to 140% of the company’s public float, with every incentive to bankrupt a company that employs over 40,000 people during a pandemic. In the eyes of the public, Wall Street hasn’t learned its lesson and buying GameStop shares has become a protest vote (and a ticket) to finally make Wall Street pay by triggering the short squeeze.

Diamond hands to the moon

Since 25 January, when the GameStop short squeeze started to gain momentum, r/wallstreetbets has seen its numbers swell from over two million members to seven million and counting. As its numbers have grown, so has the GameStop movement. Members continually post important news, updates, and memes about GameStop and why they — and their diamond hands — are utterly determined to buy and hold the stock to the moon. (WE LIKE THE STOCK!)

Big names like Elon Musk, Chamath Palihapitiya, Mark Cuban, and Kevin O’Leary aka Mr. Wonderful have publicly backed r/wallstreetbets and its bunch of retards. International media have spread their story around the world. And people have taken to advertising on New York billboards and planes to lend their support to the collective cause.

Rival hedge funds and their billionaire owners have battled over short squeezes several times in the past like when Carl Icahn took on Bill Ackman over Herbalife from 2012 to 2017. But this is the first time in history that retail traders and people from all walks of life have banded together like a hedge fund to stave off a short seller, save a company, and perhaps make some money in the process.

We’re in the endgame now

It’s important to remember that the current share price of GameStop has nothing to do with company fundamentals (GameStop is probably worth US$15-30 per share) and everything to do with market fundamentals: all short positions eventually need to be closed. But with GameStop’s short interest currently at 113.31%, there are simply not enough shares available in the market to do so. Hence, the impending short squeeze.

However, there are no guarantees in life and the short squeeze may not play out like how all GameStop shareholders hope to. (Disclosure: I have a small position in GameStop partly because I personally support the cause and partly because… I LIKE THE STOCK. We actually wrote about GameStop in March 2020 but, unfortunately, I didn’t buy that early.) So if you’re a GameStop shareholder yourself, here are five key risks that you need to be aware of as we reach the endgame:

1. Paper hands keep folding

As GameStop continues to blow up, it will attract more people who are in just to make a quick buck. These paper hands could buy up some stock, wait for the price to go up, and then sell for a quick profit. Remember, the short squeeze will only be triggered when people continue to buy, hold, and push prices up until the shorts cave in. The retards on r/wallstreetbets understand this. But if paper hands continue to sell when the stock reaches a higher price level, then the short squeeze may never really take off.

2. Short attacks

On 28 January, something incredible happened. A number of U.S. brokerages including Interactive Brokers and Robinhood (which many r/wallstreetbets members use) suspending retail buying of GameStop shares. So even if you had to cash to buy, you couldn’t. What happened next during the day was a series of short attacks that plunged GameStop from a high of US$469.42 to US$132.00 that allowed hedge funds to close out some of their shorts.

When the market reopened the following day, Robinhood would allow traders to purchase and hold up to five shares of GameStop. (So if you already had five shares in your account, you couldn’t buy more.) This amount was steadily reduced to two shares and then one share later during the day.

Why did the brokerages suspend and restrict retail buying? The official explanation from Robinhood is that, because of volatility, it had to limit buying for certain stocks including GameStop due to liquidity requirements. The conspiracy theory is that Citadel Securities, which bankrolled the short sellers, pulled the plug. Citadel is a market maker which Robinhood sells its payment for order flow (PFOF) to. Without a market maker like Citadel, Robinhood cannot process your trades. So Robinhood chose its paymaster over its customers.

Whatever the reason was, the backlash against Robinhood was immediate. Robinhood CEO, Vlad Tenev, was questioned and savaged on CNN. And representatives from both sides of the political spectrum – AOC and Ted Cruz — called for an investigation over the trading freeze. If both the left and right are calling you out, you know you seriously messed up.

Will GameStop continue to be on the end of such short attacks and shenanigans which could derail the squeeze? We’ll have to wait and see.

3. GameStop issues new shares

A simple solution that could instantly rescue the short sellers would be for GameStop to issue new shares and increase the public float. In one fell swoop, the short sellers would have new shares to close their positions and, at current share prices, GameStop would be able to raise a huge amount of capital to turn the ailing company around.

Such a move would clearly be extremely unpopular as it would extinguish the short squeeze and dilute all shareholders. However, seeing how this movement has galvanised so many people from all walks of life, the ensuing backlash from the public could see them shun and boycott the company, effectively dooming any future recovery.

4. The authorities step in

The SEC could decide that what’s happening on r/wallstreetbets is tantamount to market manipulation and seek legal avenues to shut down the forum. If that happens, retail traders lose the primary communication platform that has allowed them to take on Wall Street. Alternatives will inevitably pop up to replace r/wallstreetbets, but the censorship would hamstring retail traders’ ability to cooperate in the world’s biggest game of prisoner’s dilemma.

The SEC could also step in if GameStop rising to astronomical prices risks causing wider contagion in the financial markets if the hedge funds, brokerages, and clearing houses threaten to collapse in a domino effect. Trading of the stock would be suspended and the authorities could then negotiate a price for the short sellers to unwind their positions, and the short squeeze is averted. But would the authorities risk interfering with the free market to such an extent?

So far, the SEC has released a statement saying that it will scrutinise the brokerages that limited their customers’ ability to trade, and has vowed to ‘protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.’

5. You are left holding the bag

The short squeeze, if it happens, will not go on forever. Prices will spike to the moon and eventually come back down as the shorts close their positions one by one. Whether you make money will depend on when you enter and exit the trade.

At the same time, it seems likely that GameStop’s short squeeze could play out for a few days. With more than 57 million shares shorted and only 51 million shares available, short sellers cannot cover all their positions even if every shareholder sold them every single share – which is unlikely to happen in one trading day, let alone during a short squeeze on the way up when shareholders are not selling.

The fifth perspective

The GameStop short squeeze is a historic event that is unlikely to happen again for a long time. No one could have predicted that a bunch of autists and retards on Reddit would unite and Occupy Wall Street a second time. After this is over, the SEC will almost certainly step in to enact, and enforce, regulations that will prevent a stock from reaching these levels of short interest again.

The game plan for GameStop shareholders is simple: Hold the line.

If millions of traders from around the world just buy and hold, the short squeeze will happen (notwithstanding market interference or foul play), and we will likely witness the largest transfer of wealth from Wall Street to Main Street in a single generation.

As fate would have it, this moment in time fell onto a company with a motto that best defines this most epic of fights between the rich and the rest of the world:

Power to the players.

Adam Wong

Adam Wong is the editor-in-chief of The Fifth Person and author of the national bestseller Lucky Bastard! which made the Sunday Times Top 10 Bestseller's List in 2009 and Value Investing Made Easy which made the Kinokuniya Business Bestseller's List in 2013. In 2010, he appeared on U.S. national television on the morning show The Balancing Act. An avid investor himself, Adam shares his personal thoughts and opinions as he journals his investing journey online.

11 Comments

  1. “….hedge funds illegally sold short up to 140% of the company’s public float, with every incentive to bankrupt a company that employs over 40,000 people during a pandemic”

    Companies don’t go bankrupt just because its share price has drop (whether due to shorting or otherwise)……
    Eg if DBS share price is shorted to say $1 tmr after subjected to massive short attacks, is it going to be bankrupt

      1. hi Adam,

        By definition, every short seller (hedge or retail or otherwise) will have incentive that the company shorted has its share price fall while every ‘long’ will have incentive the companies share price grow

        Agree there are many scare tactics shortsellers can engage to scare shareholders into further selling but If the business is doing fine, no amount of shorting or scare tactics will drive the business into bankruptcy or put employees out of work either directly/indirectly. Share price being shorted by itself will not affect the underlying business.

        Personally, i am not a shortist myself. However, not sure why it was neccessary to add the part on incentive to bankrupt a company employing 40k ppl during a pandemic. My point is that to a lay person/beginner reading this article with little knowledge of shorting, that sentence can be quite misleading ie that shorting can somehow put this 40k people at risk.

        Case in point: we also will not say that folks ‘longing’ now have every incentive to bankrupt their competitors companies who employs 100,000s employees during a pandemic. Even though that too is technically correct

      2. Reason i’m raising this point is because i have a friend who asked me if it was true the hedge funds are deliberating bankrupting GME and other companies and putting ppl out of work through shorting. Other than that, it’s a good article, especially with the end game points. Cheers~

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