Competition in the video game industry has been incredibly cut-throat in recent years, and that is true for game retailers too such as GameStop. GameStop has been on a slow decline since online retailers like Amazon made two-day and even one-day deliveries a staple of their customer benefits. And as COVID-19 forced gamers inside, online stores became the primary way to play the newest games. GameStop has been reeling from store closures and staff layoffs throughout 2020 and 2021 showed no change for the dying company. That is until Wednesday, when the retailer’s stock value rocketed from just under $2 billion to an eye-watering $24 billion in just days.
GameStop and other stocks like AMC theaters and Nokia technologies are currently undergoing a cycle brokers call a “short squeeze.” Investors (big or small) often bet on whether a stock’s value will go up or down, and a short squeeze is when the bet goes bad.
Hedge fund Melvin Capital borrowed thousands of GameStop shares from a stock broker a week ago. Melvin Capital agreed to return the same quantity of shares, not price, to the broker after a short period. The hedge fund’s intentions were to sell the borrowed stock for a ridiculously low price. This traditionally causes other investors to sell their own shares and the stock price plummets. Then, Melvin Capital would buy up the extremely low-priced stock and return it to the broker, reaping the difference.
Two large hedge funds with billions to invest bet on GameStop’s stock price dropping and paid in big to the dying retail chain. Traditional shorts are essentially insider deals between well-informed Wall Street investors squaring off in the shadows, but GameStop’s short caught the eye of some unlikely investors.
Through no-fee platforms like Robinhood and E-Trade, a regular person can buy and trade stocks without a broker, or without any connection to Wall Street at all. The democratization of stock trading has left many traditional analysts reeling, as the behavior of the public is much harder to track than a handful of hedge or mutual funds.
All eyes are on the Reddit Wall Street Bets page after its users gained a collective interest in the GameStop stock early this year. The page is largely responsible for the first push of the “squeeze” on Melvin Capital’s short. When the GameStop stock dropped suddenly, forum users bought the stock and actually drove the price up. Social media furthered the buying shockwave and soon enough, regular armchair traders were buying the GameStop penny-stocks that Melvin Capital hoped would convince investors to lower the price. The forum-users’ motivations vary from personal interest in the retailer to a deliberate effort to squeeze out the hedge funds that bet on GameStop flopping. Several forum members used the phrase from the Batman movie The Dark Knight, “It’s not about the money, it’s about sending a message,” to describe their motivations.
Wall Street quickly took notice of the grassroots squeeze and now there is a mounting squeeze that has left hedge funds like Melvin Capital, the fund which orchestrated the original short, in need of a $2.75 billion cash infusion after their original investment in the company exploded in value.
Many have read the armchair trader movement as a protest against the elitist lifestyle of hedge funds like Melvin Capital. Sen. Elizabeth Warren (D-Mass.) spoke in depth about the GameStop short squeeze saying, “For years, the same hedge funds, private equity firms, and wealthy investors dismayed by the GameStop trades have treated the stock market like their own personal casino while everyone else pays the price.”
Companies like Melvin Capital are moving money from traditionally strong stocks like Apple and Alibaba in order to cover their insanely high bills to brokers. Melvin Capital, in particular, is expected to be wholly bankrupt by the end of this week according to market analysts.
The story with GameStop’s stock is not over yet. As of the publishing of this article, the stock is still on the rise. Melvin Capital said in a statement Monday that they have formally retreated from their short and are in the process of paying their original broker multiple billions of dollars.
Despite the fact that GameStop’s corporate stock is worth staggeringly more money per share, GameStop is still a dying company. Just weeks before the short, the company announced the closure of more than 1,000 stores by March. GameStop has been reporting net losses for the past three years consecutively. Nothing has meaningfully changed for the retailer, and the stock is considered extremely overvalued and risky. Experts predict that a future mass sell-off could be catastrophic for not just GameStop, but the stock market at large.