The GameStop Trade Summary

The setup:

Several Hedge Funds were shorting stocks to the tune of 140%. It is possible if you use leverage thru options and margin accounts. A group of private investors collaborated on the Redditt Social media site to purchase Game Stop. Many of these investors were gamers who saw the stock at a low price point and purchased with hopes to see the company succeed. When this community of investors saw the opportunity, they leveraged short interest and decided that it could make the stock more attractive- potentially with a chance to spike to the upside, generating an immense increase in buying interest.

The problem:

When these investors started to buy, they used both leverage and options, forcing the market maker in the stock to start accumulating more shares in anticipation of greater buying interest. Then, the short-sellers started getting margin calls and either had to (1) sell other assets to increase cash or (2) close out their short positions in the stock. This caused a massive imbalance with people trying to buy with limited availability in the stock. The price began to rise higher by the minutes. When the short-sellers wanted to cover, they could not find stock because there were more short positions than outstanding shares available. Short positions borrow shares to deliver in on their short sale, making this situation even more complicated. A $15 stock climbed to over $500 in a matter of days.

The Why:

Several potential reasons for this explosive short squeeze have been discussed over the last week. The most common claim for a cause seems that the Redditt traders wanted to expose the extreme leverage in the markets caused by groups such as specific hedge funds. The investors involved are assumed to have acted with one main goal in mind: to bring the ramifications of these levered trades to regulators’ attention, such as the SEC. It has also been stated that this may have been an attempt to initiate regulatory control changes to avoid another market meltdown like 2000 and 2008. The current leverage in the markets is similar to the levels seen in those volatile markets.

The Results:

What you hear in the press is as equally dangerous and irresponsible as these private traders involved. The real story or focus should be the investors, and this situation should be looked at as a valid policing group in these highly levered markets. There has never really been anything incident like this in history. The regulators are often afraid to make the changes necessary to help keep the markets, and investors, from abusing the system. As new technology has allowed trading from anywhere, for free, using algorithms, the market regulations have not been able to keep up. We need to update the rules and regulations to fit the new trading environment and platforms. Finally, these private traders are not the unsophisticated, mom and pop investors gambling in the market. These are intelligent individuals, some even geniuses, who do not fit into the box firms like hedge funds, mutual funds, banks, etc. Therefore, they are self-taught investors who make a living with new techniques and strategies.

What we have learned:

Do not underestimate the private investors as they are a growing community, with increasing amounts of money being traded and growing in their sophistication of the system itself. We now have a policing community of individuals who are willing to go against the Hedge funds and keep them from thinking they can make moves without anyone watching.