A best-selling fiction author could not have spun a more ironic tale so completely representative of our time. Just as an unprecedented situation—COVID and lockdowns—unfolded over the past year and led to massive gains for corporate titans like Walmart and Amazon while governments have crushed small businesses and individuals, a new, unprecedented situation has unfolded over the past week.
Spilling off the pages of Reddit to become a substantial threat to the stock market’s stability is a microcosm of this tale of big business quashing the little guy, of Wall Street profiting despite the best, most subversive efforts of the underdogs. In short, what started out as a long stock play in a subreddit full of rocketship and “diamond hand” emojis and anti-elitist snark has fueled a form of class warfare that extends well beyond rhetoric. Big Tech and Wall Street are fighting back, and right now it appears they’re winning.
You Do Need Some Background
The background of this story may seem dry to some, but as with “The Big Short” of ’08, the full extent of malfeasance and recklessness by big Wall Street players can’t be understood without some working knowledge.
Reddit user u/DeepF*ckingValue has been touting the potential of GameStop (GME) for months. Seen as a dying retail breed, its stock price had hovered around $5 per share for several years as people move away from brick and mortar for video games and more towards digital copies of games and online purchases of consoles.
Enter Ryan Cohen, the founder of Chewy, which he sold for a cool $3 billion back in 2018 after successfully competing with Amazon for the e-commerce dog food market. After stepping away from dog food domination, he turned his sights towards GameStop, buying a 13 percent share in the company and joining its board of directors in mid-January. This move boosted the stock price, but it was still trading under $20.
While a visionary joining a failing company has brought about spikes in stock price in the past, GameStop had another unique factor against it. Its stock, GME, was shorted at an astronomical rate by several hedge funds, including Melvin Capital. A short position is taken when a person or fund believes the stock price will go down. They borrow against the current market price with the intention of paying it back when the market price is lower.
For example, stock A is trading at $3. Bob believes it will drop to $1 and shorts 100 shares of stock. He “sells” those stocks immediately for $300. In a week, if the stock price goes to $1 he can close his stock position and buy the 100 shares he “borrowed” for only $100. At the end of it all, Bob makes $200.
However, if a week later the price rises to $5 per share, he could close out his short position by paying $500 for 100 shares at $5 per share. In the end, he’d lose $200 on his bet.
Bob has another option if his short position isn’t looking too hot with a current price of $5 per share. He could stick with his short position and hope it drops back down to $3 or less sometime in the future to cover his current paper loss. The risk with this is that his loss potential is theoretically unlimited. If he holds onto his short position for another week and the stock price rises to $10, he’s even more in the red.
This is only one of the ways you can short a stock. The bigger you or your fund is, the more complicated a short position can become, all the way into “naked” short (selling a stock you haven’t even borrowed yet, akin to listing and selling a home you don’t even own), which are illegal but hard to track and therefore rarely prosecuted.
Back to GameStop
GameStop was shorted at 140 percent of all the shares available to purchase, meaning it is likely more shares were shorted than there were to buy back to cover those short positions. This should never happen and suggests the types of shorts that were used were questionable at best and illegal at worst. So u/DeepF*ckingValue and a group of redditors saw an opportunity: take advantage of those who are taking advantage.
What has unfolded over the past couple weeks has been a run on purchasing GME stock to try and buy up as much shares as possible to take advantage of this short position. Buying all those shares naturally drove up the stock price, but it also did something else. Every time the price went a little bit higher, hedge funds that had massive short positions took more and more of a loss as they were forced to buy an ever-increasing stock to cover their short positions.
As reddit user u/myne put it:
[Hedge funds] short-sold AT LEAST 40% more shares than ever existed. They’re obliged to buy back more shares than is possible. The only way out of that self-made trap is a complicated mess of desperately buying, returning, rebuying from the people you borrowed them from, and returning them with losses at every step. Imagine if I sold you 10 cars, but only delivered 6. You’re standing there with your wtf face and I say ‘Hey! how much would you sell those 4 cars for?’ You can name your price at this point. I pay it. Then I ‘finish’ my ‘10 car delivery.’
At this point, some fund managers and individuals exited their short position realizing that as long as people who were long GME held their position, the stock price would continue to go up and there was nothing they could do about it. This is known as a short squeeze.
As short positions become due and shorters have to cover these positions, they’re forced to buy at the price set by the shareholder. Since these same shorters shorted more stock than was available to buy to try and make an extra buck, they’re now at the mercy of those holding the shares, leading to exponentially increasing prices.
Punishing Hedge Funds for Cheating
While some shorters realized the potential losses could be catastrophic, others decided to double down on their position. Melvin Capital lost 30 percent of their portfolio value by Jan. 25, or close to $4 billion. On that day, Citadel and Steven Cohen gifted Melvin Capital $2.75 billion to help cover their losses. They then doubled down on their shorts and their losses have skyrocketed. On Jan. 25, they announced they finally exited their short positions.
This is when the war with individual retail investors started. While it cannot be technically proven that Melvin didn’t exit their short positions, short positions on GME as a percentage of available float were still at the same 140 percent.
Statistically, this should’ve fallen off hard if Melvin really did sell their short positions. Thousands of retail investors thus doubted this news and continued to hold onto their stocks. GME stock had continued to skyrocket. Last Friday, it closed at $65 per share. Yesterday it closed at $345 per share. Last night, u/DeepF*ckingValue’s initial $50,000 position grew to $50,000,000, and he’s continuing to hold.
Now, a lot of short positions will become due on Friday, and that’s when the much-anticipated short squeeze is expected to kick in. What started out as a humorous stock projection has become a realistic prediction. We might see GME share prices above $1,000. With this attention on targeting heavily shorted stocks, other stocks have seen massive gains as well, including AMC, BB, and NOSS.
Aftermarket trading last night pushed GME close to $500 and bankruptcy for funds with heavy short positions seemed to become more and more probable. It appeared that the underdog small-time investors betting against the big hedge fund pessimists successfully dealt a blow to Wall Street know-it-alls.
Robinhood Turns on the Little Guy
Then suddenly this morning, Robinhood suspended the ability to purchase shares of GME, AMC, and others due to “market volatility.” Of course, you still can sell these shares, you just can’t buy them. And what happens to a stock when you can only sell it or hold it? People sell it and losses start to pile up. Within an hour, GME dropped from $469 to $132 and AMC dropped from $12 to $7. Several traders reported orders from last night being cancelled.
This may seem like a responsible reaction to slow volatility, but one doesn’t need to look that deeply to see what’s really going on. Mega hedge fund Citadel gave Melvin Capital, the company with the most to lose the higher these prices go, a $2.75 billion bailout. According to Yahoo News, “Citadel’s founder is Ken Griffin, who also founded Citadel Securities, a big investor in Robinhood that also works with TD Ameritrade and Charles Schwab.”
The company that touts “democratizing finance for all,” that many redditors have relied on to foil the fat cats’ plan to short a beloved videogame store, is really stealing from the poor to give to the rich. Within an hour, billions have been transferred from individual retail investors to hedge fund managers in the name of Robinhood. Its app store rating plummeted from 5 to 1.
This is a blatant act of market manipulation, and lovers of freedom on both sides of the aisle should be outraged. In a free market, stocks should be able to be bought or sold at any time and foolish actions should reap negative consequences—even if those consequences come via spiteful “average joe” investors who’ve likely gone through a hellish year where they’ve felt squeezed and short-changed by establishment elites in government and big business.
You’re probably wondering what’s next. That depends on the constitution of retail investors. The subredditors of r/wallstreetbets have received an overwhelming amount of support for the hold position as trade volumes indicate the price crash was caused by very few sellers but high-frequency small trades that artificially crashed the price.
This is Melvin’s/Robinhood’s/Citadel’s/Cohen’s last battle effort before the inevitable short squeeze tomorrow. As long as retail investors hold, they should see their position skyrocket. But do they have the strength to do so as prices artificially tanked? Considering GME has recovered to $246, it appears they might. This is a once in a decade spectacle that has pitted retail investors against hedge fund managers, with irony off-the-charts: a platform called Robinhood screwing small-time investors? Really?
Whether the trend of Big Business succeeding while the average American suffers continues through 2021 is anyone’s guess. But we deserve a better ending than bitter irony.
