Wednesday, February 3, 2021

GameStop “Short Squeeze”

In January 2021, a short squeeze of the stock of the American video game retailer GameStop (NYSE: GME) and other securities took place, causing major financial consequences for certain hedge funds and large losses for short sellers.  Approximately 140 percent of GameStop's public float had been sold short, and the rush to buy shares to cover those positions as the price rose caused it to rise even further. The short squeeze was initially and primarily triggered by users of the subreddit r/wallstreetbets, an Internet forum on the social news website Reddit.  At its height, on January 28, the short squeeze caused the retailer's stock price to reach a pre-market value of over US$500 per share, nearly 30 times the $17.25 valuation at the beginning of the month. Many other heavily shorted securities also saw price increases.

On January 28, multiple brokerages, including Robinhood, halted the buying of GameStop and other securities, later citing their inability to post sufficient collateral at clearing houses to execute their clients' orders. This decision attracted criticism and accusations of market manipulation from prominent politicians and businesspeople from across the political spectrum, and dozens of class action lawsuits were filed against Robinhood in U.S. courts. In reaction to brokerages halting the buying of GameStop and other securities, the total market capitalization of cryptocurrencies and metal futures increased.

Background on the Short Squeeze

GameStop, an American chain of brick-and-mortar video game stores, had struggled in recent years due to competition from digital distribution services, as well as the economic effects of the COVID-19 pandemic, which reduced the number of people who shopped in-person. As a result, GameStop's stock price declined, leading many institutional investors to short sell the stock. However, in September 2020, Ryan Cohen (the former CEO of online pet-food retailer Chewy) revealed a significant investment in GameStop and joined the company's board, leading some to believe that the stock was undervalued.

Short selling and short squeezes

Short selling is a finance practice in which an investor, known as the short-seller, borrows shares and immediately sells them, hoping to buy them back later ("covering") at a lower price, return the borrowed shares (plus interest) to the lender and profit off the difference. The practice carries an unlimited risk of losses, because there is no inherent limit to how high a stock's price can rise. This is in contrast with taking a long position (simply owning the stock), where the investor's loss is limited to the cost of their initial investment.

Short sellers are exposed to a risk of short squeezing, which occurs when the shorted stock jumps in value due, for instance, to a sudden piece of favorable news. Short sellers are then forced to buy back the stock they had initially sold, in an effort to keep their losses from mounting. Purchasing the stock to cover their short positions raises the price of the shorted stock, thus triggering more short sellers to cover their positions by buying the stock. This can result in a cascade of stock purchases and an even bigger jump of the share price.

Online discussion

The subreddit r/wallstreetbets is an online community on Reddit, a social news website. The community is known for discussion around high-risk stock transactions.  On January 22, 2021, approximately 140 percent of GameStop's public float had been sold short, meaning some shorted shares had been re-lent and shorted again.  Observers congregating around r/wallstreetbets believed the company was being significantly undervalued, and with such a large amount of the shares being short they could trigger a short squeeze, by driving up the price to the point where short sellers had to capitulate and cover their positions at large losses.

Even before the short squeeze, there had been interest in GameStop (ticker symbol: GME). Keith Gill, known by the Reddit username "DeepFuckingValue" and the YouTube and Twitter alias "Roaring Kitty", purchased around $53,000 in call options on GameStop's stock in 2019 and saw his position rise to a value of $48 million by January 27, 2021.  Gill, a 34-year-old marketing professional and Chartered Financial Analyst (CFA) from Massachusetts, stated that he began investing in GameStop during the summer of 2019, after believing the stock to be undervalued. He shared information, as DeepFuckingValue, regarding his investment on the subreddit r/wallstreetbets, providing regular updates on the investment's performance, including times when the investment had plunged. He stated on January 29, after the GameStop short squeeze, that he "thought this trade would be successful" but "never expected what [had] happened over the last week", adding that he planned to continue his YouTube channel as Roaring Kitty and potentially buy a house.

On January 27, technology news website Mashable reported that the subreddit had broken pageview records due to the short squeeze, receiving 73 million pageviews in 24 hours. r/wallstreetbets was the fastest-growing subreddit – the community surged by more than 1.5 million users overnight (to a total of 6 million members) on January 29.

Possible causes

Due to the COVID-19 pandemic, consumer spending in general was drastically lower than normal. There was also more money in the hands of investors as a result of historically low interest rates and an inability to spend their money elsewhere.  Other suggested factors included a culture of taking massive gambles on the stock market in the hopes of making money quickly, anger of some investors towards Wall Street hedge funds for their role in the financial crisis of 2007 and 2008, or the general democratization of the stock market coupled with the ability of retail traders to communicate instantaneously through social media.

Timeline

Rise in stock price and volume

In January 2021, Reddit users on the r/wallstreetbets subreddit built the foundations for a short squeeze on GameStop, pushing up the stock price significantly.  This occurred shortly after a comment from Citron Research predicting the value of the stock would decrease.  The stock price increased 1,500 percent by January 27 over the course of two weeks, and its high volatility caused trading to be halted multiple times.  According to Dow Jones market data, more than 175 million shares of GameStop were traded on January 25, the second largest total in a single day, surpassing its 30-day average volume of 29.8 million shares.

In conjunction with the short squeeze, the resulting increase in options volume triggered a gamma squeeze as a result of market makers needing to buy shares to hedge their increasingly short exposure.

After GameStop's stock closed up 92.7 percent on January 26, business magnate Elon Musk tweeted "Gamestonk!!" along with a link to the r/wallstreetbets subreddit.  A brief, sharp rise in the share price to over $200 followed Musk's tweet.  As of January 28, 2021, the all-time highest intraday stock price for GameStop was $483.00 (nearly 190 times the record low of $2.57 in April 2020).  In pre-market trading hours the same day, it briefly hit over $500.

The r/wallstreetbets Discord server was banned on January 27 for violating the company's restrictions on hate speech.  However, users quickly formed similar servers on the application, and Discord reversed its decision the next day, attempting to help the community moderate its server instead.

On January 27, r/wallstreetbets triggered a short squeeze on AMC Theatres (ticker symbol: AMC), a company in a similar position to GameStop.  The value of AMC Networks (ticker symbol: AMCX) also increased significantly, which was believed to have happened because of the stock's name being similar to AMC's.  Disruptions and restrictions limiting trade have been reported on multiple brokerages such as Charles Schwab Corporation, its subsidiary, TD Ameritrade, and Robinhood.  According to Bloomberg, US trading volumes (by share count) on January 27 exceeded the peak set in October 2008 during the financial crisis, and was the third-highest in dollar terms within the last 13 years on record.

Halting of stock purchases

On January 28, Robinhood halted purchases of GameStop, AMC Theatres,  BlackBerry Limited, Nokia Corporation, and other volatile stocks from its trading platform; customers could no longer open new positions in the stock, although they could still close them.  Other brokerages soon followed suit. Many traders were furious, and called for class-action lawsuits in multiple popular Reddit posts.  After the markets closed, Robinhood announced it would begin to allow "limited buys" of the affected securities starting the following day, although it was unclear what "limited buys" entailed.  Trading platforms such as UK-based Trading212 and Israel-based eToro blocked buys of GameStop and other stock while continuing to allow sales.  Webull halted  by orders for stocks affected by the squeeze, but soon thereafter allowed orders to continue.  Anthony Denier, the CEO of Webull, stated that increased collateral requirements for their clearing house meant Webull themselves were restricted from opening new positions.  Some users alleged that Robinhood was selling shares without consent; Robinhood denied these allegations.

Several brokerage firms, including Robinhood, stated on January 29 that the restrictions were the result of clearing houses raising the required collateral for executing trades.  Because there is a two-day lag between the moment when investors purchase a security and the moment cash and securities are actually exchanged, brokerage firms have to post collateral at clearing houses to guarantee the proper settlement of their clients' orders.  Clearing houses include the Depository Trust & Clearing Corporation (DTCC) for equities and the Options Clearing Corporation (OCC) for options.  Clearing houses must have enough collateral on hand to settle       a member’s outstanding transactions in the event any particular member firm fails—to prevent cascading failures of other members — and can demand additional collateral (i.e., margin calls) from members if market volatility starts to increase.  Brokerage firms claimed that the increased collateral could not be provided in time, and, as a result, trading had to be halted.  The DTCC, for instance, increased the total industrywide collateral requirements from $26 billion to $33.5 billion, noting that the large trading volumes in specific stocks "generated substantial risk exposures at firms that clear these trades [...] particularly if the clearing member or its clients are predominantly on one side of the market".  On January 29, it was reported that Robinhood had raised an additional $1 billion to protect the company from the financial pressure placed by the increased interest in particular stocks and meet the collateral requirements of clearing houses.

As of January 29, Robinhood still imposes limits on the trading of GameStop, AMC, and Blackberry stocks.  On January 30, Robinhood announced it had increased the restrictions from the sale of 13 securities to 50, including companies such as Rolls-Royce Motor Cars and Starbucks Corporation.  However, on January 31, Robinhood announced it had removed several of these restrictions and would only limit the sale of eight securities.

Decline in value

On February 1 and 2, the stock price for GameStop declined substantially, losing more than 80 percent of its value from its intraday peak price, recorded during the previous week. GameStop shares lost 60 percent of their value on February 2, closing below $100 for the first time in a week.  Reports estimated that about $27 billion in value had been erased.  Other assets affected by the short squeeze, and put under company trading restrictions, such as AMC and Blackberry shares, also declined in value.  CNN reported that the drop was partly due to restrictions imposed by Robinhood and other brokers on the number of shares that could be purchased at once by their clients.

https://en.wikipedia.org/wiki/GameStop_short_squeeze

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