[31 Jan, 2L54pm: updated with new links]

This is going to be one of the millions of posts on the subject but I thought I should put it out anyway and my value on this subject is in bringing together all the different viewpoints on the subject.

What’s up with GME (and other meme stocks)?

First, we have to start with what happened. The short (pun intended!) story is that some time in 2020, some hedge funds (notably Melvin Capital and Citron Research) put it out there that they were short Gamestop (ticker: GME).

GME was already a name that was being floated around on the subreddit, Wallstreetbets (WSB), as a stock that some redditors were long either via the stock, call options, or both. Maybe it was due to a sense of nostalgia (many of these redditors on WSB grew up with Gamestop) or they correctly identified it as an opportunity to create a short squeeze (at one point, short sellers were short 148% of the stock, more on this later) and profit from this trade.

The momentum started building in January 2021 when the redditors on WSB started buying up swaths of stock and call options, thus pushing the price higher. This caused losses on the short sellers’ positions and presumably, short of these short sellers scrambled to cover their positions by buying the stock. This caused prices to go even higher, thus perpetuating a positive feedback loop for prices. This was the result of not just shorts having to buy stock to cover the shorts (i.e. a short squeeze) but market makers having to buy stock in order to remain market neutral to due an increase in buyers of call options (i.e. a gamma squeeze). ERN has a nice summary of the various market forces at work.

One of the main reasons that the redditors on WSB correctly identified that the short was ripe to squeeze was the fact that there were more shares shorted than the amount of shares available. In essence, the shorts had taken on a position that was highly leveraged as they would have to eventually return more stock than what was even in existence.

The squeeze was further fueled by billionaires such as Chamath joining the fray and when brokerages such as Robinhood started restricted the purchase of stock (thus limiting the squeeze), it drew outrage from WSB and got the attention of those in Washington (notably AOC, Warren and Cruz).

At this point, the story isn’t over. The SEC has said that it is looking into ensuring that retail investors get to trade and will be protected. The news has made international headlines (I joked that since our local paper, The Straits Times has reported on it, the ride’s probably over). On Friday, the stock initially traded much higher pre-market and then came down from those levels. However, the stock still closed around 60% higher compared to Thurday.

Did the David really stick it to Goliath?

The story behind WSB and GME has gotten so much attention because it’s a classic underdog story. It’s a story of how individuals may be weak but if they stand together, they can be so strong that forces worth billions of dollars can be forced to fold.

But is the story really that simple?

I feel that if you look beyond that narrative, you may find that things are a little more complicated. After all, one of the people that profited greatly from this episode is Ryan Cohen, the co-founder of Chewy.com who placed a huge bet on Gamestop being a turnaround story. But credit where credit is due, while he isn’t one of the small guys, Ryan Cohen was putting his money and resources on the line to try and turn around what he saw was something of value.

The lucky idiot in this story is Gamestop CEO George Sherman. His shares are now reportedly worth somewhere near $1b. This is a CEO who joined in 2019, given tons of stock options, was sitting in a sinking ship, and instead of drowning and going down with the ship, he’s now wealthier than ever before? Granted that this is all paper wealth and as CEO, he probably hasn’t even had enough time to put in place a turnaround plan while he had to deal with the external environment brought about by COVID-19, but still…He’s now been given a lifeline to recapitalise the company. His job has been made infinitely easier.

Also, I’m skeptical that the redditors on WSB managed to execute the squeeze without the any bigger forces at work. That would only work if their brokers extended tons more margin in order for them to leverage up. Either that or they used the gains in previously held positions like TSLA (another WSB favourite which saw massive gains in 2020) in order to take on position in GME.

WSB has tried the same squeeze on other names such as AMC, BB, BBBY, and NOK but those are unlikely to go as well as GME. Even then in those cases, look who’s benefited the most? Another lucky idiot. It’s not the small guy.

What’s next?

Now that the SEC is involved, it probably won’t end well for retail investors. Josh Brown tells the story of a similar situation that happened a 100 years ago. Given that the brokerages are restricting trading in these volatile stocks because their clearing houses have asked them to increase the amount of collateral to clear these trades.

In short, the market is already throwing sands in the wheels to slow down these trades. There’s going to be more friction when trading in these stocks and if there’s more friction, that’s simply going to take away the momentum. Without, the momentum, I think retail investors are going to find huge losses in the highly leveraged positions and then subsequently in the long positions themselves.

There are lots of very smart people discussing this story right now and I think if you really want to learn about what happened, I would check out the following:

I hope this helped.