GameStop is a retail chain of videogames and consumer electronics in the US. As we know, offline retail is a dying industry and GameStop had been facing its share of challenges.
Up till now, that is.
The share price of GameStop was $19 sometime in mid-December and it trades at $134 right now! That is 600% increase. (Nope, not because of Harshad Mehta).
What happened that led to this berserk rally? Let’s discuss!
Backdrop
Melvin Capital and Citron Research are two hedge funds that manage multi-billion dollar wealth for their investors. They could see GameStop was dying as a firm and shorted its shares aggressively. (Basically sold them expecting to buy after a price drop which would lead to $$$ for them)
What does shorting mean?
In equity markets, if you feel a company’s share price will go down, you have the option to sell a share first and then buy later at a lower price. For instance, if Reliance is trading at INR 100 and you feel the price will drop- you borrow a Reliance share from someone and sell it again in the open market.
Now if the share price goes to INR 90, you can buy it in the open market (and make INR 10 as profit) and settle that share with whoever you borrowed it from. However, if the share goes to INR 120, you buy it at that price and take a loss of INR 20.
Basically, if you short the share and its price drops, you earn money. If it rises, you lose money.
What happened with GameStop?
The share market is a game of demand and supply. If you short billions of worth of shares of a company, it pushes the price down. Companies that have billions in capital often do that. That is what Melvin Capital and Citron did. Now they were waiting for the shares to plunge. However, a community of retail traders on reddit “WallStreetBets” found out about it.
So they decided to rather start buying the shares of GameStop (When you buy shares, the prices go up) in big numbers. Millions of traders came together to buy and this spiked the shares price.
Double Whammy!
Now, say the share went from $19 to $38 because of excess buying and demand. Since Melvin Capital and Citron were looking at losses of billions, they also had to buy the shares (the ones they shorted)at $38 which eventually pushed the prices even higher.
Both of the hedge funds are looking at bankruptcy.
What next?
Nothing really has changed with GameStop. They did not discover oil in their stores. Fundamentally, its value is still very low. The share market reflects the real value of a company and eventually, it will. I think the shares will plunge soon - so if you are planning to buy it, you might need to reconsider the decision.
No one can time it though. Also, US traders are weird.*
*A company named Zoom Technologies saw its share price rocketing during lockdown because American thought it was Zoom Video Conferencing. (Do you think it’s just Indians that confuse Snapchat and Snapdeal?)
Can this happen in India?
No. In India, we do not have hedge funds that carry naked short positions on equities of companies. Moreover, the derivatives of such companies (if they exist) aren’t liquid enough to take positions of this size.
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