Gamestock: How Redditors Turned a Video Game Retailer into a Fortune 500 Company

Gamestop+stores+%28like+this+one+in+Melbourne%2C+Australia%29+have+been+liquidating+and+closing+for+years

Gamestop stores (like this one in Melbourne, Australia) have been liquidating and closing for years

Noah Glasgow, Editor-in-Chief

On Friday, January 22, a share of the video game retailer Gamestop (GME) was worth $45.94. It was one of the most heavily “shorted” stocks on the market: Financial institutions had placed bets that would pay off when the stock’s price fell. But by Tuesday the 26th, Gamestop stock was worth $145.96. And just two days after that, at 10 AM on Thursday the 28th, Gamestop hit an incredible high of $469.42, becoming a Fortune 500 company – one of the 500 most valuable stocks in the world. Suddenly, all the Wall Street investors who had bet against Gamestop were out thousands, millions, and, in some cases, billions of dollars. But who was responsible for the sudden market turnaround?

The answer: amateur or “armchair” traders, playing the stock market from the comfort of their homes. They had done something unprecedented, using online platforms including Reddit’s r/wallstreetbets to band together and initiate a “short squeeze,” or a series of bets in favor of Gamestop that actually managed to raise the stock price. For many (including myself) reading about the Gamestop short squeeze, articles in the Wall Street Journal and New York Times were overloaded with financial lingo and technical intricacies. I didn’t fully understand how the Gamestop “squeeze” had worked. What was a “short?” How do “options” work? Why was Melvin Capital suddenly out 2.75 billion dollars? And, most importantly – was all of this really legal?

To understand the Gamestop squeeze, you have to start at the beginning: When major financial institutions, like the aforementioned Melvin Capital, decided to bet that Gamestop’s value as a corporation was in decline. The bet they placed is called a “short.” To execute their short, Melvin Capital borrowed thousands of Gamestop shares (most likely from a hedge fund) at a low interest rate and then sold them to whoever wanted to buy. Let’s say, for the sake of ease, that these shares were worth $100 a piece, and that they’d been borrowed at an interest rate of 5%. In the future, Melvin would return these shares to the hedge fund after simply going out and buying these shares back off the market. If the price per share had gone down, as Melvin suspected it would, then the price per share during the buyback would be a lower number than what the shares had first been sold for. All told, Melvin Capital might have sold a share for $100, bought it back later for $80, and paid $5 in interest – pocketing a neat $15 dollars. 

In theory, Melvin Capital is under no obligation to share their short bet with the general public. Except, almost any major institution that heavily shorts a stock will announce their decision. But why? Well, Melvin will announce that they’ve bet against Gamestop and then explain why. They’ll say that the company is in decline, that the retail video game industry is collapsing, that digital sales are the future, etc. Then other financial institutions will agree with the provided reasoning and sell off any Gamestop shares they own. Of course, a bunch of shares being sold off simultaneously will depress the share’s price, fulfilling Melvin Capital’s bet. In other words, just by placing their bet, Melvin Capital has essentially ensured its desired outcome. This entire cycle is commonplace and entirely legal.

Except this time, things didn’t work out as planned for Melvin Capital. Amateur hobbyists known as “armchair traders,” who buy and sell tiny increments of stocks via online platforms like E-Trade and Robinhood, saw that the major institutions had heavily shorted Gamestop. On r/wallstreet bets, a community that’s equal parts financial advice and memes, these amateur traders decided to rally around Gamestop and make Wall Street eat its risky bet. Trading in tiny increments, they had little to lose. Internet-savvy and fanned by their resentment of “crooked” hedge funds, the Redditors decided to initiate what’s called a “short squeeze.” In other words, they decided to raise the Gamestop stock price just enough to make Wall Street’s bets unprofitable. To do this, the Redditors would have to raise the price of Gamestop’s stock to above what Melvin had initially sold it for. Eventually, major institutions would be forced to buy back the shares they had borrowed before they suffered huge losses on their bets. This sudden rush for stock would drive up price, and if you owned a bunch of Gamestop stock that you’d bought for cheap, then you would stand to make gobs of money. But the question remains: How does one “squeeze” the market, or raise the price of stock enough to hit a profitable tipping point?

The secret lies in buying “options.” If I think that the price of Gamestop is going to rise, I can go to a stock broker and say, “Right now, Gamestop is worth $100. I want the right to buy it for $150 dollars in a month, regardless of the market price at that time, and I’ll pay you a very small amount of money for a contract that gives me that right.” Purchasing this contract is called buying a “call option.” If the market expects a stock’s value to rise, then call options are expensive. The ability to purchase a stock in the future for less than its market value at that time means you would stand to make a profit. This type of call option might cost a few dollars. But if the market expects a stock’s value to fall (i.e. Gamestop), then call options are cheap: Why would you want the right to buy a stock at a higher price in the future if its price is predicted to fall? This call option might cost only a few cents.

  The call option I suggested above – one that bet Gamestop’s value would rise – would have been dirt cheap a few weeks ago, given that Wall Street’s top firms had predicted (and bet on) Gamestop’s declining value. But thousands of Redditors and amateur traders went out and bought those cheap call options anyway. This sort of nonsensical behavior began to confuse the markets. The firms selling the call options went out and bought just a small number of cheap Gamestop shares, on the off chance that the Redditors’ call options would suddenly prove profitable. This practice is known as covering your “delta,” and it’s pretty common. Since firms began covering their deltas, demand for Gamestop stock increased, and the share price went up. Since the share price went up, more people began buying those extravagant call options. This made the share price go up as more firms had to cover more “deltas.”

But the truth is, these price increases were relatively small. At the start of the year, Gamestop stock was worth $19 dollars. The self-reinforcing cycle of options and stock purchasing doubled that, but certainly didn’t push the stock price up past $400. The tipping point came when Gamestop’s stock had increased enough to put all of Wall Street’s short bets in serious trouble. 

Wall Street had so heavily and mercilessly bet on Gamestop’s collapse that even a few-dollar stock increase rendered billions of dollars in short bets unprofitable. Suddenly, the price to buy back the stock was higher than the price it was sold for. To minimize losses, all of the major Wall Street firms went out and tried to buy back Gamestop shares before the stock price rose even higher and made the bets even more unprofitable. It was this sudden rush by firms to cover their Gamestop shorts that sent the price skyrocketing. Demand was huge, and the price rose accordingly. Ultimately, the Redditors had engineered a bubble that was suddenly massively profitable. They could now sell their call options – the literal contracts they had purchased –  to firms that could afford to buy the stock when the time came. After all, the average person can’t take delivery of thousands of $150 dollars stocks, which was the right these options provided. The ten-cent contracts were suddenly ten-dollar contracts. 

Things seemed to grind to a halt on Thursday the 28th, when the trading app Robinhood disabled its users’ ability to purchase more Gamestop stock. Amateur traders could only “close out” their positions, or sell off their existing Gamestop assets to major hedge funds and firms. Suddenly, the ability of the amateur traders to profit off the bubble they had created was limited, while major firms were free to buy and sell Gamestop shares at will. Robinhood’s decision was unprecedented, and quite possibly illegal – a case of market manipulation. In theory, only the Securities and Exchange Commision (SEC), which regulates the U.S. financial markets, can stop trade. A number of Washington senators and representatives on both sides of the aisle cried out against the regulations, demanding hearings to clarify why and how the decision was made. 

At the time I’m writing this, the future of Gamestop’s stock is uncertain. In fact, the future of the entire stock market is uncertain. Gamestop’s precipitous and volatile rise will almost certainly twist the market’s leading indexes. These complex computer formulas predict and model the market’s future. If leading indexes drift too far out of line, it could lead to any number of unknown consequences. Already, Wall Street suffered its worst week since October, taking a 3% hit as a direct result of the Gamestop short squeeze. And the r/wallstreetbets traders are holding strong to their positions, refusing to sell off stock and options in the hopes that it will raise the stock price and make Wall Street’s Men in Suits suffer the worst of their bets. Nostalgic for the old days of Gamestop and ready to stick it to The Man, the amateur traders are quoting Heath Ledger in The Dark Knight, “It’s not about the money. It’s about sending a message.”

In addition to investigating Robinhood, it seems likely that the SEC will investigate the major corporations that heavily shorted Gamestop, as well as the progenitors of the squeeze, for financial fraud and market manipulation. In the meantime, we can only watch as events unfold. If teams of amateur traders can inflict billions in damages on major Wall Street firms, it could signal a serious decentralization of America’s financial system. Whatever the ultimate impact, the Gamestop short squeeze is an unprecedented and fascinating twist in the history of the U.S. stock market.