The Lesson Of GameStop: Quite Simply A Short Squeeze
Most people know GameStop (GME) as a retail outlet that sells all things related to video games. As many retailers these days, it has two clear survival paths: 1) Reinvent itself to become an omni channel retailer (i.e., sell more online) or 2) Suffer the fate of many brick & mortar retailers, do nothing and slowly die. This synopsis has very little to do with what drove this stock up from $17 to over $400 to now down to $50+ in little more than a month.
Much has been made about how a group of individuals on the social media site Reddit took it to the
professionals (hedge funds) in an effort to destroy them, all the while making a ton of money. Terms such as “hold the line,” “this is going to the moon” and “YOLO” (you only live once) were bantered about as GME stock rose indiscriminately. The fervor grew and the momentum was unstoppable…until it wasn’t. So, what really happened here?
Two words: SHORT SQUEEZE. It doesn’t matter how the media portrays it or social media dignitaries lending their voice to the cause…the fact is, this was a good ole-fashion short squeeze. I get the David versus Goliath narrative the media depicted, but regardless of who the participants were, this is nothing more than a short squeeze.
Most people participate in the stock market by investing today with the intent of making money in the future. In technical terms it is called opening LONG (purchase of stock) then closing SHORT (selling the stock). There is another group who participate in the stock market hoping for stocks to go down; called “short sellers”. They open SHORT and close LONG. (See the chart for the mechanics of how investors short stocks.)
Short sellers look for compelling reasons to bet against a company, in particular ones with gloomy future prospects. Enter GME. The more compelling it becomes; short sellers tend to pile into the stock (either through outright stock ownership or options). The greater number of short sellers in the stock, the greater the short interest (i.e., total percentage of a stock’s float that is shorted). When short interest gets high enough, that’s when the potential for real fun begins…a short squeeze!
In GME’s case, the short interest was over 100% (which is odd to begin with). Needless to say, a lot of negativity, so much so it can draw the eyes of people looking to cause a short squeeze. Enter, the WallStreetBets crowd on Reddit. Somehow, someway, these folks started buying the stock and options driving the price of GME up. The stock market does have a supply and demand effect in the short-term for sure. Specifically, if there are more buyers than sellers (i.e., demand), the stock price is likely to head higher.
Well, when a highly shorted stock keeps heading north, short sellers have to make some hard and fast decisions to either exit their short positions or hold in the hopes the stock comes back down. Once the short sellers start closing their positions (remember, this is done by buying the stock) this just drives the stock price up even more. Hence, a short squeeze. In GME’s case, there was a hedge fund that not only had a short position on GME, but it was also highly leveraged. This only poured more gasoline on a raging fire. Regardless of their investment thesis, they had to close their position.
Judging by the stock price returning somewhat back to Earth, the fervor surrounding GME seems to have faded. And while investors (more like traders) made some serious money on the way up into the $400’s, there has been some real pain on the return trip under $100 a share. Are the short sellers back… who knows? Will the Reddit crowd return to try and cause another short squeeze… who knows? Will there be copycat situations that arise from the excitable legions communicating via social media… who knows?
What we do know is 1) Short selling is dangerous, 2) The GME story was driven by traders, not investors, and 3) while the media would like you to believe differently, there is no law that states you have to take a position in every single stock… especially the stock du jour (or in this case, the stock of the month)!
Next time a spectacle like this appears, do your best to watch from the sidelines (maybe be entertained), learn something if you can… but do your best to not get caught up in it. As the great John Salley once uttered: always “Stay in your lane.” We are long-term investors interested in real long-term wealth… we’ll stick to this lane.
Note: Nothing contained herein this letter should be considered to be investment advice, research or an invitation to buy or sell any securities. Chart source: Statista, FT.