GameStop Corporation is known for being the world’s largest video game retailer, but in the last month, it became the financial markets’ hottest topic.
Hedge funds are speculative funds managed by insurance companies or private entities with the aim of obtaining from their operations the largest return. Some of these funds, which move billions and billions of dollars, clashed with young and inexperienced private investors who got their act together through the Reddit forum “WallStreetBets”.
It all started when some institutional investors, like Melvin Capital, saw the opportunity to profit from short-selling GameStop shares.
Everything would have gone unnoticed, but the “WallStreetBetters” decided to buy GameStop shares en masse, through direct share’s purchase or options, because they thought the stock was undervalued. The GameStop stock prices skyrocketed and damaged short-sellers, who, instead, sell one or more securities by betting on their future downside.
GameStop’s shares hit bottom last year at $2.57, before closing 2020 at $18.84 because of the backing of other hedge funds. From there, the share’s price has increased progressively until other hedge funds have started to speculate against the video game giant by short selling a large number of its stocks.
That’s where WallStreetBets amateurs come into the story: many users on Reddit started to advise people to buy GME’s shares in order to short squeeze (a process consisting of raising the price to put pressure on short-sellers). The latter ended up with the stock price well above $350 on Wednesday. Therefore, anyone who borrowed GameStop shares previously during the year and traded them on the market for $18.84 would have found an additional $301.64 per share to buyback. And because some hedge funds had borrowed millions of GME’s shares, this action resulted in tremendous losses for the hedge funds, which were left to buy back the shares to prevent those losses from increasing excessively. This whole share buy-back increased demand and pushed the price even higher.
Although GameStop is, perhaps, the first time a private case in which retailers had the power to cause such important losses to large institutional retailers, some of the WallStreetBetters are doomed to lose considerable sums when GameStop’s price will fall, like happened in the first February session: the stock dropped to $225, which corresponds to a one-day price decrease of 31.5%.
This is the proof of the influence that social media can have on financial markets and short-sellers, who reconsidered their bets against companies sentenced to failure. For example, the online investment newsletter Citron Research said it will begin to invest in companies with development potential and cut their short positions. From now on, institutional investors will have to take more into account the widespread online sentiment on forums like Reddit.
The GameStop case also raises questions about the ethics and legality of online collusion aimed at raising share prices, especially because the markets’ battlefield between private investors and hedge funds has shifted to other stocks that the hedge funds fall short of, such as BlackBerry, AMC, and American Airlines.
According to a study by Bank of America, in recent days the volume of trading operated over the counter – unregulated circuits – has risen above 50% for the first time, which explains the total lack of interest of the markets during the week of the short squeezes.
After the Reddit Rebellion Week, Joe Biden’s US Government seems ready to intervene: Treasury Secretary Janet Yellen has gathered the main financial regulators to discuss eventual limitations in the extreme stock volatility caused by the action of Reddit users. Heads of the Securities Exchange Commission, the Federal Reserve, the Federal Reserve Bank of New York, and the Commodity Futures Trading Commission will gather to determine what countermeasures could be taken to protect investors and markets. Several members of Congress also sought probes into the investment apps Robinhood and Citadel (Robinhood’s anonymous controller) which have been accused by the media of “democratizing” the financial markets.