GME: The Battle of the Two Streets
In this article, I’m going to cover the GameStop extravaganza that has recently taken over the media. Instead of boring you with the plain details of what’s happening, I’m going to explain why the guys up in Wall Street are reeling in pain. Put simply, we are seeing a pushback against the establishment. Main Street versus Wall Street. Main Street being us regular folk, against the men strapped up in their tailor-made suits on Wall Street.
We’re off to the Moon, but where did we launch from?
The fundamental reason GameStop was shorted is due to the digital transition from disks to downloads. Next-generation video game machines released in late 2020 had one caveat, no disk drives. Well, that’s not entirely true. Both the PlayStation and Xbox machines had a cheaper diskless option on offer, making them more attractive to customers. However, with a significant proportion of GameStop’s revenue generated from trading in used games, there was clearly a problem. GameStop was viewed as the Blockbuster of video games, a relic of old consumption habits, barely scraping by in a digital world. So, what changed?
In June 2020, GameStop reported a 519% jump in online sales when they were forced to shut down their physical stores. In August 2020, billionaire and Founder of Chewy.com (an American online retailer of pet food and other pet-related products), Ryan Cohen, disclosed he had acquired a 9% stake in the video game retailer, with grand plans to turn it into an Amazon rival. Shortly after, GameStop announced a multiyear strategic partnership with Microsoft to expand both physical and digital stores. But that’s when some Reddit users on WallStreetBets discovered the stock was shorted 138% spurring on the short squeeze.
What is a Short Squeeze?
To understand a short squeeze, you need to understand the fundamentals of shorting stocks, and how losses and profits are made. When you think the price of a stock will go down, you can choose to short that company. When you short a company, you must first borrow a share from somebody else, with the intention of returning it back at some point in the future. Once you borrow the share, you resell it immediately, leaving you with the cash value. Now from here, two things can happen:
If the price of the share you borrowed and sold goes down, you can buy it back at a cheaper price, and then return it back to the person you borrowed it from. You pocket the difference between the price you originally sold it for and the price you bought it back for.
If the stock price goes up, you will be forced to buy back the share at a higher price, and when that happens, you’ll lose money when you must return those stocks.
When you go long on a $10 stock, the most you can lose is 100% of the stock value. But when you short a stock for $10, the most you can lose is an infinite amount of money, because the stock can keep on going up… to the moon.
A short squeeze occurs when you have many people, all of which are short on a stock, being forced out of their positions by a sharp increase in the price. As short sellers begin to buy back the shares, it adds further buying pressure in the market, which can cause the price to rise even higher, forcing more and more short sellers to cover their positions. Due to the nature of shorting, if the Hedge Funds don’t cut their losses, the losses could, in theory, become infinite.
Why are the Hedge Funds in trouble?
The Subprime Mortgage Crisis of 2008 caused one of the most severe economic recessions of all time. People lost their jobs, homes, and livelihoods, meanwhile, the bankers who caused it, got a slap on the wrist and an enormous check from President Bush. Now, we’re once again seeing the divide widen between the rich and poor. With aggressive quantitative easing and ultra-low interest rates, institutions have been prospering. It has never been cheaper for large companies to acquire smaller companies and IPOs are more popular than the next-generation games machines! Well, this time Main Street spotted the same negligence from 2008. A handful of members from the now famous, Reddit Group, WallStreetBets, spotted GameStop was over 138% shorted by various Hedge Funds. These people wondered how it’s possible to short 40% more shares than actually exist in the world. It didn’t make any logical sense. What we’re seeing is an online community taking a united stand against Wall Street. Armed with their now, not so favourite broker, Robinhood, Main Street is fighting back against the corrupt and broken system, making them finally pay for the 2008 crash.
Another reason why this GameStop debacle has caused so much pain is because Hedge Funds are sheep, aimlessly following their leader, Melvin Capital. Gabriel Plotkin, CEO of Melvin Capital, is one of the most respected individuals in the industry. His trades are copied by many other Hedge Funds, irrespective of the stock market trade. So, when the trade goes wrong, it goes against all of them, at the same time. I’ve spent a considerable amount of time looking through WallStreetBets, and I’ve concluded that if everyone published their fundamental research, it would be hard to distinguish the best version of research from WallStreetBets to that from a Hedge Fund. The Hedge Funds have lost their edge, and this is what we’re exposing. All of a sudden, retail traders can be on the same footing and they don’t have to be the ones to suffer anymore. Main Street has exposed the huge amount of risk Wall Street has taken, exploiting, and exposing their overconfidence to the world. However, Main Street is being blamed for inflated prices since profit taking is reserved only for Wall Street.
What’s the real problem here?
Why are Hedge Funds allowed to be leveraged up by astronomical amounts of money? They take a $10 billion fund, go to their Prime Brokers, (a ‘do it all’ department sitting in the Global Markets division of an Investment Bank) who allows them to run $100 billion of notional exposure. Who thinks that that’s fair? It’s not! Especially when a trade goes south, leaving them with a $100 billion hole in their pocket which is exactly what happened in 2008.
With Wall Street kicking their feet, reeling from their humiliation, the regulators will act. However, if the SEC (U.S. Securities and Exchange Commission) wants to impose more regulations on anyone, they should have their sights set on Wall Street. If they want to take the gun away from the baby, let’s make sure they figure out who the baby is first. The real problem isn’t with the billions of dollars being traded by retail; it’s the trillions of leveraged dollars being traded by Hedge Funds. If Hedge Funds are confident enough to oversell a company to the extent that they’re selling 40% more shares, which don’t even exist, they shouldn’t be surprised when people wake up and smell the disposition. Wall Street missed it and they paid the price.
In conclusion, I believe regulators need to review how they allow companies to be over 140% short. We’re moving towards a world where normal, ordinary people have access to the same information that institutions have. There will definitely be more volatility like this in the future, but the solution requires more transparency on the institutional side, and not less access and ability for retail.