You’d have to be living under a rock if you hadn’t heard about what’s happening to GameStop yet – the meteoric rise in the stock price of the unprofitable chain of game stores has captured the attention of finance bros and regular joes everywhere. The stock, worth as little as $40 five days ago, grew almost 10x, closing at $347.51 at the end of day (Jan 27). It is no secret that one of the major catalyst for its rise is the subreddit r/WallStreetBets. The de facto leader of the movement, u/DeepF******Value, bought 50,000 shares of GameStop at ~$15, as well as a bunch of call options, which is now together worth close to $50,000,000.
So what happened? How did a bunch of presumably unsophisticated teenagers make so much money? Is this stock going to the moon? Is this considered securities fraud? Should we buy a bunch of out of the money calls and get rich, so we no longer have to format slides to the right shade of blue for what comes out to be $40 an hour? Do I still have to learn financial modelling if stock prices are not making sense fundamentally? (the answer is an emphatic yes, how would you know GameStop is not making sense fundamentally if you don’t know how to calculate its value?)
What happened to GameStop?
Basically, r/WallStreetBets found that GameStop was heavily shorted, to the tune of 140% short interest (meaning 140% of its float is being shorted). This is apparently very abnormal, and if someone with enough money was to buy its stock or buy calls to raise its price, it could cause a short squeeze and cause the stock to rise more. There’s also something called a gamma squeeze, which could further boost stock prices. This is the technical argument that has floated around the subreddit for a while.
Now, this alone isn’t compelling enough, but last week Ryan Cohen disclosed that he has taken on a major position at GameStop, and is taking on a board position. Ryan Cohen is the former Chewy CEO, a successful tech entrepreneur/executive, and the hope here is that he would be able to turnaround the loss-making company and digitize its operations. However, this fundamental story isn’t the whole picture either, there is no way the current valuation is justifiable fundamentally, no matter how good the company becomes at selling games on the internet in the future.
What had really captured the attention of redditors and other retail investors alike is not the fundamental or technical rationale, but the Goliath in the story. Melvin Capital, a hedge fund managed by Gabriel Plotkin, is heavily short on GameStop. Gabriel Plotkin was a start portfolio manager at SAC Capital Advisors, the infamous fund managed by Steve Cohen. The redditors, mostly Millennials or Zoomers from the middle or lower levels of the economic strata, wanted to take down the fund for shorting the company that they love (many love games and have fond memories of buying games from GameStop). This David versus Goliath story is certainly not idiosyncratic, distrust in the current system and the establishment is what caused Trump to be elected, and is likely a contributor to the black lives matter movement.
The drive to take down this particular hedge fund became a proxy for a larger movement, an extension of occupy Wall Street if you will. This became the main rallying cry behind the stock, and some notable players like Chamath Palihapitiya and Elon Musk publicly joined the fight. In this case, David won. On Monday, Melvin Capital supposedly lost 30% of its value, and required a capital injection from its billionaire friends. On Tuesday, Melvin Capital lost an undisclosed amount and closed out its positions.
Is this stock going to the moon?
This is obviously not financial advice, but it is highly unlikely that this stock is going to the moon. As much as we want to see the little guys beat up the big guys, there is no fundamental or other rationales that this stock would remain at such elevated valuation for long. Now of course, contrary to the efficient market hypothesis, stocks are NOT always priced at the discounted value of their future cash flows. Stocks are priced at where the majority of the participants think they should be priced at, regardless of what methodology they are using to get that price. In this case, most redditors think the stock is going to the moon (or $1000), and many other people think that most people think that the stock is going to the moon, so it becomes a self-fulfilling prophesy. However, there are many off-setting forces at play, many other institutional investors with pockets deeper than redditors that think the stock should be reflective of their fundamentals. Even as many short sellers are exiting the market, many new ones are coming in. It is likely that these short sellers will win at some point – after all, redditors and other supporters will run out of cash at some point.
Is this considered securities fraud?
The answer is: maybe. Very boring I know. I have no knowledge whatsoever of securities law so you would have to be an idiot to take my advice, but Matt Levine knows it, and he discussed this here (not legal advice either). Basically, as it was a coordinated effort to “manipulate” the market, but no one has really lied about anything (AFAIK), it is not clear whether or not anyone committed securities fraud. There is some precedent of SEC action on “market manipulation” without someone outright lying, but the circumstances were very different.
Should I buy some calls or puts on Gamestop?
Again, not investment advice, but the general advice is don’t bet more than you are ok with losing. To quote a redditor’s eloquent response to another short seller:
We remained retarded longer than OP [original poster] could remain solvent.
This stock is no longer just a reddit meme stock, there is most likely institutional money at play here. The volatility is huge and the stock could swing in either direction. Perhaps there’s a volatility play here, I’m not smart enough but if you are message me and let’s make some money!