Gamestop and Stocks

[JBMcB]

Here's a summary of the Gamestop situation with a primer on short selling.

A short position is where you sell an option to buy a stock to someone else at a specific price. So, let's say it's January, and you think a company is overvalued at $100/share for some reason. You can sell an option to buy a stock to another investor at, say, $90/share in September. If the stock goes down to $40/share when the option comes due in September, you buy the stock at $40 and sell it to the buyer for $90/share, making $50/share profit. If the price goes *up* however, the short seller is on the hook to buy the stock at whatever price it's at when the contract is due. This is why short selling is limited to investors with a lot of cash on hand because the most you could ever make on short selling the above stock is $100/share, as that is how much the price could fall, maximum. The amount you could lose, however, is unlimited, as the price could go up to $1000 a share, and you would be *losing* $900/share. The thing to keep in mind is often, when selling these contracts, the seller does not currently *own* the stocks, but borrows them from other investors they have agreements with, or signs similar option contracts to buy them at a specific date from another investor.

So what happened in the Gamestop situation, is that a hedge fund called Melvin Capital took on *huge* short positions on Gamestop. We're talking billions of dollars of short contracts. These are all coming due this week. A couple of weeks ago, a bunch of individual investors [[called "Retail" investors) on a Reddit subforum found out about the short position. This is not unusual, as all stock trades are public information - anyone can find out who is buying or selling what. What *was* unusual was the size of the short. So the group of Reddit investors started buying up shares of Gamestop. Lots of shares. The thing is, to cover their short position, the hedge fund was going to have to buy a *lot* of shares, above what they had contracts to buy. In the meantime, the price starts creeping up, making other investors hop on board causing the price to increase even more. Then, it's time for the hedge fund to start buying up shares to cover their short, driving the price up even more. This is called a short squeeze. You know that some huge institutional investor is going to be hoovering up shares, which should drive the price up a bit, so if you are large enough to bump the price up a little bit, the resulting increase is amplified, driving the shares you own up even more. The last part of all of this is that, as the Redditors took a dim view of hedge funds taking these short positions, they all agreed that they wouldn't sell their shares to Melvin, starving them of shares and driving the price up even more.

There is nothing illegal about any of this. There is no insider information being used, as all transactions are public record. The only thing keeping the large hedge funds doing this to each other, as far as I can tell, is professional courtesy. The end result is that Melvin Captial is loosing *huge* amounts of money on this short, as they were planning on the stock price being somewhere around $10/share, and it's currently trading somewhere around $300 a share. So, that is the price at which they have to purchase shares, to cover their contracts to sell the same stocks at $10/share, or whatever their short position was.

By the way, this isn't too far away from what Valentine and Winthorp did to the Duke brothers at the end of Trading Places. In that case, though, Valentine and Winthorp made it seem like the price of OJ would increase due to a fake crop report delivered to the Duke brothers, causing them to buy contracts at high prices [[that Valentine and Winthorp sold) After it was revealed there wouldn't be a bad crop of oranges that year, they waited for the price to collapse, and bought the shares they sold contracts for at a very low price. Also, while buying the cheap shares, they refused to buy from the Duke's trader, making their own contracts worth even less. As the Dukes were buying the high-priced but ultimately worthless contracts on credit, by the end of the trading day they were bankrupt, and kicked out of the exchange as they could not cover their contracts regardless.

Online trading platforms have subsequently stopped their users from buying more Gamestop stocks, causing quite a bit of outrage. Politicians weighing in run the gamut:

A.O.C. and Ted Cruz agree that what the independent investors are doing is fine [[!)

Elizabeth Warren thinks the SEC should investigate the independent investors [[?)

When asked about it at a White House briefing, press secretary Psaki said that the Treasury now has the first female head, and that the stock market is not a good indicator of American prosperity - so she had no idea what the reporter was talking about