Wallstreet vs Reddit

It’s not unknown to anyone that the gap between the commoners and the megacorps has increased over the years. We have Google threatening to shut down its services in Australia if the new laws which allow news media to ask for a revenue share from the search engine’s business. It’s impossible to imagine our world without Google and same is the case with many other mega-corporations. It’s not hidden that these companies influence various policy decisions of the Governments across the world due to the power at their behest and their mammoth status. When Governments cannot fight them, it’s foolish for a commoner to even think of pulling out a fight with such corporates. However, a bunch of Reddit users think otherwise.

Gamestop, a small retail company worth less than USD 400 million a few months ago is today a USD 10 billion company. Within a span of few days, the stock price of the company which was trading at USD 43 on January 21 went from bottom to top of the wall street charts on January 27 when its price peaked at USD 469. And it’s not that the company has some big announcement or mega project under its sleeves. It’s just another corporate struggling to retain its business after the pandemic. The same is evident from the fall in the price of Gamestop as the price is once again USD 53 on February 4. So what is happening with a rarther not so happening stock? Well, its not the company, but its fortune that it was caught in the middle of an unexpected war between the giant traders on the wall-street and a united front on the Reddit.  We will get back to that, however, before that firstly, let’s know what is Gamestop.

What does GameStop do?

Gamestop is a retail company which sells offline video games, consumer electronics and gaming merchandise through its stores across the United States. In the current scenario, it’s a rather failed business as the gaming world has moved online. Do note here that Gamestop is the largest video game retailer in the world with 5,509 retail stores in the United States, Canada, Australia, New Zealand and other European countries. The company primarily operates its retail stores under the brand name GameStop and other names such as EB Games, ThinkGeek, and Micromania-Zing. Formed in 1984 as Babbage’s and later renamed to GameStop, the company seen huge success from 2004 to 2016. However, the market for physical video game declined and thereon began the downfall of GameStop.

In April 2020, after the pandemic and lockdown, while struggling to move its business online, GameStop announced that it is closing 450 stores in the United States, as the company was suffering losses. The company has been in controversies for its response to Covid-19 pandemic, as many people lined up at its stores for new game launches.

What happened on January 27?

The Gamestop stock which was happily trading around USD 30 surged to USD 300 within a period of 2-3 days with a peak at USD 469 on January 28. The stock surge created USD 2 billion for its three largest individual shareholders, however, none of them has been reported to have sold their shares. The Wallstreet was taken by surprise as the surge in the GameStop price was backed by small investors buying the stock using Robinhood app and such other new trading services. Nothing changed about the company, it was merely investor sentiment. On further investigation, it turned out that a large number of investors were inspired by Reddit based on the discussion on a subreddit Wallstreetbets, or as the Redditers put it /r/wallstreetbets. Reddit is a social forum where people share memes, comment, discuss and place their opinion, generally humorous. However, the subreddit wallstreetbets to whom nobody paid attention so far, suddenly received the attention from the Reddit community when they started betting against the real wall street big boys and winning as well.

Why did the stock price double in a few hours?

Ryan Cohen who was formerly Chief Executive Officer (CEO) of online pet-food company Chewy Inc was recently added to the board of GameStop and also acquired 12% ownership to help the company grow and succeed. Ryan has been a successful entrepreneur and he believed that GameStop could thrive as an online e-commerce platform. He became more and more vocal about it. The users behind the subreddit wallstreetbet believed in the words of Ryan and his move towards online platforms against the prospects of doomed business according to the experts. While the group of retail investors, on one hand, believed that Ryan would change the fortune of company and thus, started buying more and more shares of the company; the hedge funds on the Wall Street were short-selling the stock, expecting a fall in the shares in near future. This led the stock price being pushed to new and new higher levels and soon the stock price exploded. Trading of the shares was temporarily halted by New York Stock Exchange for at least nine times to contain the volatility, however, the stock price doubled in merely few hours. GameStop became the single most traded stock in the United States. 

How were the big investors squeezed?

Let’s say a box of apple currently costs USD 10. Your friend has 10 such boxes. You think the prices of apples are going to fall and you wish to make a profit out of it. So you simply borrow apples from your friend and sell it in the market at the current price of USD 10. Later when the prices fall, you buy the apple boxes from the market at say USD 8 and earn a profit. You now have apple boxes which you return to your friend and pay a small fee to him. This is called Short Selling – selling, even when you don’t own the product.

In the stock market, this friend is your broker. He allows you to short sell shares. The hedge funds on the wall street had done a similar transaction for the GameStop – borrowed the shares from the brokers and short sell the same in the market, in a bid to drive the prices lower and buy them back. However, the guys at subreddit wallstreetbets probably noticed the same and started buying shares against the bets of the giants. They successfully convinced many other Reddit users who joined the bandwagon and started buying shares. And in no time, the shares of GameStop surged and the retail investors made money. However, the hedge funds were in a problem, as they had gone short on the stock.

What is short squeeze?

When you are short on a stock and if the price rallies, you are in a bit of trouble. There are two situations here – losses to be mitigated and then the borrowed stocks to be returned. While the hedge funds have big pockets, nobody expected that the stock would rally from USD 50 to USD 469 at one point. So, firstly the hedge funds suffered huge losses. Now there’s a second problem of returning the borrowed stocks. There’s no option here – the hedge funds had to buy these shares from the open market and return it to the broker. This resulted in a further surge in the share price. This is called a Short Squeeze. And thus, the wallstreetbet players made a profit out of the whole GameStop saga.

What else did the Reddit guys do?

The smart minds behind the wallstreetbet and the others who joined them not only bought the shares of GameStop from the market but also bought the call options of the shares. Now, a call option is a contract whereby you have the right to buy the shares of a particular stock on a future date called the settlement date. However, call options are usually not held till settlement date and used as an option for trading. Now, when someone buys a call option, there is somebody else who is selling the call option. Thus, if the price rises, the person selling the call option would be in trouble. Thus, such sellers usually hedge their bets by buying the stock from the market. So if price rises and you are in losses, the shares you hold (whose value keeps increasing) offset the losses and thus, your profit or loss is secured. However, when Reddit users started buying call options in a frenzy, the sellers of the call options also started buying the shares to hedge their position. Thus, this further led to an increase in the price of the stock and what happened after that is history!

The strange world we live in

The retail investors aka the common man, are beating the professionals at their own game. Those at Wall Street have raised their eyebrows to weigh in on the matter and call out this frenzy trading as ‘madness’. When professionals buy shares of loss-making companies and push their valuations to billions, nobody questions them. When the venture capitalists invest in startups and tell everyone that this is going to be a billion-dollar company, people call them visionaries, not madness. It’s a strange world we live in.