The GameStop Fiasco

Author: Akash Dhanuka | 7th March 2021 | Read Time: 3-5 mins 

GameStop—a stock much talked about in 2021—making headlines everyday globally. We’ve all heard about it, but how many of us actually know the history/events behind this sudden media attention? This stock has experienced  high volatility, with movement range being $2.57 to $ 483 (52-week period)!!

Hello everyone, I am Akash Dhanuka, a final year undergraduate student from St Xavier’s College, Kolkata. I am currently preparing for my CFA exams and interning as an Equity Analyst in a hedge fund to expand my knowledge about the world of financial markets. I am passionate about finance and I enjoy reading about and exploring new things.

I take this opportunity to share my research & study on the GameStop fiasco and hope to provide some helpful insights to all finance enthusiasts and readers of the QForum Blog!!

About GameStop

GameStop is a Texas based US organisation established in 1996 that offers games and amusement items in more than 5,000 stores and is building a complete web-based business store across 10 nations. GameStop offers a choice of new and used video gaming consoles, embellishments, and computer game titles, in both physical and computerized designs. They are famous for being a Brick-and-Mortar computer game retailer. The company was not doing well before the Novel Corona Virus and has been doing even worse after that. The company’s profit was down from $408 million in early 2011 to losses to the tune of $275 million in 2019.

The Story

Over the years, GameStop’s stock had been falling–hedge funds were heavily short selling the stock (as the company was restructuring and going digital, the HFs believed the company would not be successful in doing so), particularly the $13 billion hedge fund Melvin Capital. The stock was a topic of discussion in WallStreetBets (a subreddit where participants discuss stocks) since mid-2019 when a Reddit user posted a picture showing a $53,000 investment. In this short-squeeze (refers to a phenomenon where short sellers in a stock who have placed their bets on a stock’s fall, rush to hedge their positions or buy the stock in the event of an adverse price movement, to cover their losses), the short sellers lost an estimated $23.6 billion on GameStop in this rally. Melvin Capital lost 30% of the $12.5 billion (before the short-squeeze) it invested in managing shorted stocks, and by the end of January 2021 had suffered a loss of 53% of its investments. Data from equity analytics firm Ortex showed that as of January 27, there were loss-making short positions on more than 5,000 U.S. firms.

Some brokerages, including Robinhood, discontinued the buying of GameStop and other securities, later mentioning their inability to post sufficient collateral at clearing houses to implement their client’s orders. This decision drew criticism and allegations of market manipulation from prominent politicians and businesspeople from across the political spectrum. Dozens of class action lawsuits were recorded against Robinhood in U.S. courts, and the U.S. House Committee on Financial Services conducted a congressional hearing on the incident. Later in February, Netflix announced plans to develop a movie based on these events.

Let us understand the math behind this fiasco!

On 27^th January 2020, the free float of GameStop (represents the portion of shares of a company that are in the hands of public investors as opposed to locked-in shares held by promoters, company officers, controlling-interest investors, or governments) was 33 million. The shares shorted were 70 million and there were 2 million live call option.

Now one thing to know is that US markets have different rules and according to them if you are selling a call option, you need to hedge your position by buying shares of the company. So, for writing 2 million call options you need 200 million shares as a hedge.

So, the total net short position in GameStop’s stock was:

(200 -33) + 70 shares = 237 million shares (i.e., more than 7 times the free float)

As the price went up, the call sellers had to buy stocks to offset their calls, but they were not able to because only 33 million shares were free float, this lead to Fail-to deliver shares rising.

The GameStop stock appeared on the list of SEC everyday at the end of January.

The number went down drastically on 29^th January, the day after some brokerage houses halted the buying of GameStop.

The Effect on Cryptocurrencies

I believe volatility in GameStop’s stock led to an increase in the market capitalization of all cryptocurrencies increase to US$1 trillion, with Dogecoin’s value increasing over 800%. Users of the Reddit attempted to pump up Dogecoin to make it “the next GME/Bitcoin”. The price of Bitcoin–the world’s largest cryptocurrency, increased after Elon Musk endorsed it in his Twitter bio, partially related to the surge in the GameStop share price by Reddit users. Robinhood then began limiting the trading on Dogecoin.

The Effect on Commodity

I believe the volatility in GameStop’s stock led to an effect on the commodity market. On January 28 and 29, the price of silver rose 10 percent. On February 1, the price of silver hit an eight-year high as GameStop shares continued their volatile tendency.

Can this happen in India?

In India, an event like this is not really possible–as in the cash segment, naked short-selling (selling without owning shares) is prohibited. Investors must reveal prior to trading whether the transaction is a short-sale or not. If the transaction is a short sale, then he or she must produce the shares of the shorted securities the same trading day (i.e., Intraday only). Exchanges impose circuit filters on stocks that stop their daily price swings. SPAN, upfront, and peak margins ensure that there is no systemic risk on the payments side.

There is position limit for entities to take exposure. The combined futures and options position limits are capped at 20%of the applicable market wide position limits. So, any contract that crosses 95% of the market-wide position limit will come under trading ban and can resume trading only if the position limit goes down to 80%.

The Most Recent Update

On March 5th, after a tweet by Rayan Choen, the price rose again by 100%. The tweet featured a screenshot of a Pets.com ad. Some Twitter users speculated that the picture was a confusing message on the company’s outlook. The previous time Cohen tweeted an image of an ice cream cone, the stock price skyrocketed. We’re yet to witness how things pan out in the near future….

Some of the lessons that this one-of-a-kind event taught us is that in the practical world:

(i) Stock price rising exponentially is not always good

(ii) Short-selling can be incredibly risky and

(iii) Don’t enter the market without your own research.

I believe that following a stock like this and witnessing the fiasco unfold in real time (in 2021) will give fresh perspective and insights to finance students like us. With this article, I wish to iterate to all that in today’s world where information is freely available, we should make it a point to not drown in all the noise but use our knowledge & intellect and base our judgements on research rather than hearsay.

Thanks For Reading

Akash Dhanuka

Source:

The GameStop Game Never Stops – Bloomberg

CNBC-TV18 on Twitter on The GameStop saga

Unprecedented – Millions Of Gamestop Shares Failed To Deliver During Historic Squeeze | ZeroHedge

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