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Amateur Reddit day traders decimate hedge funds with GameStop stock rally

Wall Street has been taken by storm during the past few days, witnessing a phenomenon we dare say is nearly unprecedented.

For a while, the stock of troubled US video game retailer GameStop ($GME) has been among the most shorted on the US stock market, the prey of hedge funds However, during past months, a subreddit (a forum dedicated to a certain niche) on popular site Reddit called WallStreetBets decided to take action against these short sellers, which culminated in explosive market activity this January On this same day (28 January) last year, GameStop stock was selling for $4.21. Today, it is trading upwards of $340, thanks to a mass rally by the aforementioned day traders

Wall Street has been taken by storm during the past few days, witnessing a phenomenon we dare say is nearly unprecedented. 

For a while, the stock of troubled US video game retailer GameStop ($GME) has been among the most shorted on the US stock market, as market players such as hedge fund firms like Melvin Capital and Citron bet against the ailing retailer. The company, seen as the equivalent of the now-defunct video rental chain Blockbuster, has been struggling for years, as more and more gamers take their business online. 

However, during past months, a subreddit (a forum dedicated to a certain niche) on popular site Reddit called WallStreetBets decided to take action against these short sellers, which culminated in explosive market activity this January. 

“The idea was to punish short-sellers, and for the little guys to pummel Wall Street,” The Verge quipped. 

“The more GameStop climbs, the more money the short sellers lose.” – CNN

On this same day (28 January) last year, GameStop stock was selling for $4.21. Today, it is trading upwards of $340, thanks to a mass rally by the aforementioned day traders (also dubbed retail traders) of the WallStreetBets subreddit (which has over 3 million subscribers). GameStop stock has increased more than 680% so far this year. 

Here’s a simplified breakdown of how it all went down, thanks to The Hustle and Bloomberg:

  1. $GME was first pitched as an investment on r/WallStreetBets about 2 years ago, but the current craze built up over the past 12 months.
  2. Members on the subreddit r/WallStreetBets believed that GameStop, with 5k+ brick ‘n’ mortar locations, could turn around its fortunes by going digital.
  3. On Aug. 31, 2020, Ryan Cohen — the billionaire founder of pet company Chewy — bought up a big position in $GME (he now owns 10%+ of it) with plans to modernize the company.
  4. In the months since, a number of prominent hedge funds (Citron, Melvin Capital) revealed they were betting against (AKA short selling) $GME.
  5. Typically in short selling, you: 1) borrow a stock; 2) sell it to a buyer; and 3) if the price of the stock falls, you can buy it for a cheaper price you sold it at and return the stock to the person who lent it to you.
  6. One risk of short selling is called a “short squeeze.” Since you have to eventually return the stock you borrowed, problems can arise if there is a limited supply of the stock.
  7. In a “short squeeze,” the underlying stock will get bid up as short sellers try to get their hands on stock that they have to return.
  8. Options trading — the right, but not obligation, to buy a stock at a certain price — is also driving $GME up as institutions that sell these options are buying $GME stock to hedge their position.
  9. $GME stock is on an upward tear as these market mechanics play out and r/WallStreetBets traders coordinate their efforts.

As The Verge explains, many people are stuck at home in quarantine and bored, and consequently, interest in day trading has shot through the roof. Couple this with the fact that many US citizens have received two stimulus checks so far, and you have large group of like-minded individuals with a notable sum of disposable cash. Rallied around one cause, these young ‘everyday Joes’ have decided to take the fight to the big man. 

“What we’re seeing is essentially a pushback against the establishment in a really important way,” Chamath Palihapitiya, CEO of Social Capital and Chairman at Virgin Galactic, told CNBC after he invested in GameStop following the hype.

Eventually, hedge funds which had bet against GameStop got burned. One of these firms, Melvin Capital, “closed out its short position in GameStop on Tuesday afternoon after taking a huge loss,” the hedge fund’s manager told CNBC

The US news site noted that “amid GameStop’s explosive rally, short sellers have accumulated losses of more than $5 billion year to date in the stock, including a loss of $917 million on Monday and $1.6 billion on Friday, according to data from S3 Partners.”

CNBC also added that “short seller Andrew Left of Citron Research said Wednesday he has covered the majority of his short position in GameStop at a loss. He previously said GameStop will fall back to $20 a share ‘fast’ and called out attacks from the ‘angry mob’ that owns the stock.”

Elon Musk, whose company, Tesla, has long been a victim of short sellers, tweeted his support of the Reddit traders, directing his 43 million followers to the now infamous subreddit.

In the wake of the GameStop rally, the denizens of WallStreetBets have taken their battle against short sellers to new venues, setting their eyes (and wallets) on shorted stocks like those of Blackberry, Bed, Bath and Beyond, and theater chain AMC Entertainment, consequently saving many of these companies that have been battered by the pandemic. 

“Any talk of an imminent bankruptcy for AMC is completely off the table,” said president and CEO Adam Aron. “Today, the sun is shining on AMC.” The company estimated “that its financial runway has been extended deep into 2021.”

According to recent reports, this ‘short squeeze’ frenzy is apparently spreading to Europe as well, affecting the shorted stock of companies such as German pharmaceutical company Evotec, former Financial Times owner Pearson and Polish games developer CD Projekt.

It is anyone’s guess what stock Redditors will set their eyes on next. Whichever it is, short sellers are likely to have a bad day.