A Detailed Overview of the GameStop Short Squeeze From January 4, 2021 to January 29, 2021, the GameStop Corp. (GME) stock rose from $17.25 to $325.00, which is almost a 1900% increase in valuation (Yahoo Finance, 2021). Despite such a steep rise in the stock’s value, a large number of hedge funds suffered huge losses on their investments and saw their values fall by almost 50%.
What caused the GameStop stock to skyrocket, and how did this lead to the downfall of several hedge funds? How did these events impact other stakeholders in the world economy? What did this unprecedented incident teach us about the nature of the stock market? These are the questions that this paper will be addressing.
It’s useful to begin by understanding how the stock market functions and how company’s stocks are priced. When you own a company’s stock, you essentially own a small part of the company, depending on how many shares the company has made available to the public, and thus have the right to claim a part of the profits made by the company in the form of dividends.
The most fundamental way to give a certain value or price to a company’s share is to use a dividend discount model, the most common of which is the Gordon Growth Model. These models state that the current price of a stock is equal to the sum of all its expected future dividend payments discounted back to their present values. This is especially true during an Initial Public Offering (IPO). Which is when a company goes public and shares of the company are listed on the stock market for the first time.
However, a stock’s price is also largely affected by the forces of demand.
When the demand for the stock increases, the price of the stock rises and vice versa. Although people’s demand for a company’s stock is primarily based on the company’s current profitability. And expected future growth, high demand for a stock can also result from the overconfidence. Or sheer inexperience of investors, the stock’s volatility, as well as herd mentality.
Before looking at the GameStop stock in detail. It is important to first explain the process the stock underwent that caused such a massive rise in its value: a short squeeze. The two main positions that an investor can take towards a company’s stock is either a long position or a short position.
A long position is when an investor owns a particular stock (or any other security) and holds on to it with the expectation that its value will rise in the future and they will make a profit. On the other hand, a short position is when the investor sells a stock (or any other security) they don’t own (usually through borrowing stocks with the help of a stock broker and then paying back a fee in the future) with the expectation that the asset’s value will fall in the future.
Now, if an asset’s price/value rises in the future, for example, as a result of an increase in demand for the asset, the investors who had a short position on the asset will be compelled to buy the asset, in order to prevent facing any further losses. This panic-driven, rapidly increasing demand for the asset only puts more upward pressure on the asset’s price, adding to the misery of the short sellers, and is essentially called a short squeeze (Mitchell, Cory, 2021).
After understanding the mechanics of a short squeeze, it might be straightforward to make a connection between the rapid rise in the value of the GameStop stock and the massive losses faced by numerous hedge funds in the US and other countries.
GameStop, “an American chain of brick-and-mortar video game stores” (Section F, Tom, 2017), has been adversely affected in recent years due to the growing popularity of digital distributors of video games and the COVID-19 pandemic, which reduced in-person sales and decreased profits.
As a result, led to a decline in the GameStop stock’s value and caused a lot of institutional investors, primarily hedge funds, to short sell the stock. However, after nearly three years of underperforming, the GameStop stock finally started to rise in value in September 2020 when many retail investors started to speculate that the stock was, in fact, undervalued. This occurred after Michael Burry acquired a small (about 3.3 percent) stake in GameStop (Kim, Heejin, 2021) and Ryan Cohen made a large investment in the company and eventually joined the company’s board (Stewart, Emily, 2021).
Nevertheless, the real catalyst came when a few Reddit users on the r/wallstreetbets subreddit convinced a large number of retail investors to purchase GameStop stock. This was not only with the intention of making huge profits but also with an ulterior motive of causing a short squeeze for the hedge funds that had short sold GameStop stock. This higher trading volume brought about a rise of more than 1500% in the stock’s value within the month of January, 2021, causing several large hedge funds, like Melvin Capital and Point72 Asset Management, to face losses of up to 50%.
A Detailed Overview of the GameStop Short Squeeze
Taking a more detailed look into the timeline associated with the GameStop short squeeze, we notice from Figure 1 that the stock had a very low price and was quite stagnant before 2021, although it did rise a little after Ryan Cohen joined the company’s board in September 2020. However, the stock skyrocketed between the start and end of January 2021, primarily due to retail investors from r/wallstreetbets purchasing large shares of GameStop. The stock reached its peak on 27th January 2021, climbing to an astonishingly high price of $347.51. This was also partly facilitated by business mogul and CEO of Tesla Motors Elon Musk after he tweeted “Gamestonk!!” with the link to the r/wallstreetbets subreddit (Bursztynsky, Jessica, 2021).
Due to such a steep rise in value of the GameStop stock, along with other “meme stocks” like AMC and Bed Bath & Beyond, several hedge funds lost large amounts of money. As seen in Figure 2, short sellers, mainly including hedge funds like Melvin Capital and research companies like Citron Research, lost a total of $12.79 billion due to the GameStop short squeeze. The seemingly intentional acts of hatred towards hedge funds led to Discord banning the r/wallstreetbets server and Robinhood halting the trading of highly-volatile stocks, like those of GameStop and AMC.
This ignited widespread protests from retail investors all around the world and caused the GameStop stock price to fall significantly until March 2021. It was not long before the GameStop stock underwent a second surge in late February, 2021, increasing by almost 600% within two weeks purportedly due to GameStop announcing the resignation of its Chief Financial Officer, Jim Bell, with the goal of “transforming” the company (Duffy, Clare, 2021). After dropping by a small amount in mid-March, the stock price has been relatively less volatile since then with extremely low standard deviation from the mean value, as seen in Figure 1.
The GameStop short squeeze had varying implications for several different stakeholders in the economy. Short sellers, which mainly comprised hedge funds and investment research companies, suffered the largest losses out of all the individuals and institutions affected by the short squeeze. For instance, Melvin Capital, a hedge fund, lost 53% of its investments from the start to the end of January, 2021. Citadel LLC and Point72 Asset Managements, who collectively invested a total of $2.75 billion in Melvin, faced considerable losses as well (Chung, Juliet, 2021).
However, it is important to also note that there were other institutions, such as Senvest Management (a hedge fund). And BlackRock (an investment management company), who maintained long positions on the GameStop stock and realized high returns (O’Dwyer, Michael, 2021).
On the other hand of the spectrum are retail investors, mainly the ones from r/wallstreetbets, who cherished the over 1000% rise in their GameStop shares. However, there were still a few retail investors who bought GameStop stock when it reached its peak value or who held on to their GameStop shares even after the stock price started falling and ended up facing significant losses. The stakeholders who lent their GameStop shares to short sellers also gained from not only the rise in the GameStop stock value but also from the fee the short sellers had to pay back to them.
GameStop wasn’t the only company that saw its stocks increase rapidly in value in January 2021, even though it did experience the highest overall increase in its stock price in the month. AMC Entertainment Holdings, BlackBerry Limited, and Bed Bath & Beyond were the more well-known companies to experience massive increases in their share prices as well by about 480.1%, 104.9%, and 78.4% respectively (Yahoo Finance, 2021). This again benefited retail investors from r/wallstreetbets while adversely affected short sellers of these stocks.
Following the ban on the trading of GameStop and other highly bullish stocks, another subreddit community called r/CryptoCurrency facilitated the rapid increase in the value of various cryptocurrencies. For example, Dogecoin grew in value by about 800 percent from the end of January, 2021 to the start of May, 2021 (Coindesk, 2021). Metal futures, such as those of silver and gold, started to rise rapidly as well at the start of February, 2021.
The GameStop short squeeze, being one of the biggest headlines of the month of January, 2021, received immense attention from the US governments and various other political bodies. Representatives from the Securities and Exchange Commission (SEC), the Federal Reserve, the US Congress, and other major organizations held a meeting shortly after the GameStop stock peaked in late January, 2021 to discuss possible methods to address the short squeeze. The US Congress began an investigation into Robinhood, Citadel, and other financial services companies for giving retail investors too much freedom to manipulate the stock market. The Securities and Exchange Commission also revealed its intentions of persecuting individuals taking part in any illegal insider trading activities and of protecting institutional and retail investors from major losses (Bain, Benjamin, 2021).
At the center of all the investigation, hearings, and lawsuits was Robinhood, a financial services company that provides commission-free trading services to retail investors. The United States House Committee on Financial Services convened a hearing to discuss the role of the platform in the short squeeze. While there were claims made that Robinhood attempts to encourage its users to take on higher risk, there were also acknowledgements made to the fact that Robinhood does give a larger base of retail investors. Moreover, the ability to invest in the open market due to low barriers to entry and a no-commission business model.
Robinhood faced several lawsuits from individuals claiming that the company deliberately halted trading of highly-volatile stocks in order to protect hedge funds and other institutional investors from facing huge losses. However, despite the controversy surrounding the app. Robinhood didn’t seem to be affected too harshly in terms of its usage. The excessive attention received by the app led to more than 600,000 individuals downloading and using the app to reap the benefits of the short squeeze (Fitzgerald, Maggie, 2021).
Overall, the GameStop short squeeze not only gave us more insight into the nature of the stock market but also made us re-evaluate the ethics of stock market participation. The most important characteristic that the GameStop short squeeze taught us about the stock market is that it not only can be highly unpredictable but also cannot be a reliable indicator of the health and prosperity of a company. It shows us how a large group of retail investors pushed the GameStop stock upwards from being seemingly undervalued to being extremely overvalued. The sole reason for this wasn’t only the fact that investors saw potential in the company but also the fact that some wanted to make institutional investors suffer while others just wanted to go along with the trend and make massive profits.
If an institutional investor conducts such a form of market manipulation with harmful intentions, it is deemed unarguably illegal, however, in the case of GameStop, the market manipulation was done by a large group of retail investors, only a small part of which publicly declared that they wished to see the hedge funds suffer (McConnell, Doug, 2021). In such a scenario, is it ethical to persecute all the retail investors who facilitated the short squeeze? Is it ethical to not address the fact that a large number of hedge funds lost millions of dollars without it being their fault?
To conclude, GameStop, an American video games and electronics retailer, saw its stock price skyrocket by at least 1500% from early January, 2021 to late January, 2021. This rise in the stock’s value caused a short squeeze for institutional investors who had short sold the stock while led to innumerable retail investors earning large profits. Even though other stocks like AMC and Blackberry rose rapidly during this time period, no other stock matched the speed with which the GameStop stock grew, which is one of the reasons why it received so much political and media attention. Despite the problems this incident created, it did help us understand a little more about the nature of the stock market.
Works Cited : A Detailed Overview of the GameStop Short Squeeze
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A Detailed Overview of the GameStop Short Squeeze
- Bursztynsky, Jessica. “Gamestop Jumps After Hours As Elon Musk Tweets Out Reddit Board That’S Hyping Stock”. CNBC, 2021, https://www.cnbc.com/2021/01/26/gamestop-jumps-as-elon-musk-tweets-out-reddit-board-thats-hyping-stock.html.
- Duffy, Clare. “Gamestop Shares Surge More Than 100%”. CNN, 2021, https://www.cnn.com/2021/02/24/investing/gamestop-shares-climbing-again/index.html.
- Chung, Juliet. “WSJ News Exclusive | Melvin Capital Lost 53% In January, Hurt By Gamestop And Other Bets”. WSJ, 2021, https://www.wsj.com/articles/melvin-capital-lost-53-in-january-hurt-by-gamestop-and-other-bets-11612103117.
- O’Dwyer, Michael. “Hedge Fund Makes $700M On Gamestop Bet”. The Telegraph, 2021, https://www.telegraph.co.uk/business/2021/02/04/hedge-fund-makes-700m-gamestop-bet/.
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- Fitzgerald, Maggie. “Robinhood Appears To Be Benefiting From The Trading Controversy, Seeing Record App Downloads”. CNBC, 2021, https://www.cnbc.com/2021/02/01/robinhood-appears-to-be-benefitting-from-the-trading-controversy-seeing-record-app-downloads.html.