The Big Short Squeeze: An Account Of The Gamestop Saga
Gamestop (the stock) has had a big week last week. Somehow, the story of a bunch of (self-proclaimed) retards throwing away their life savings because they saw a bunch of rocket emojis became the underdog story of retail investors sticking it to hedge funds/the establishment by beating them at their own game, and the establishment retaliating via underhanded tactics negotiated in secret backdoor meeting. Accusations of market manipulation have been thrown on both sides, and politicians, billionaires, and other scoundrels have jumped in to cash in on the attention.
I'm not sure that that narrative is really "correct" (whatever correct means -- let's say, "grounded in reality?"), so I will just note some things from my perspective for posterity. I'm writing mostly for people who do not have a super detailed understanding of how the markets work (like myself), so I'll begin with some basics for context.
Short Squeeze
A short squeeze consists of two things: a short (many shorts) and a squeeze (many squeezes).
Short
Shorting/short selling means selling a stock when you do not own it.
This is done by borrowing the stock from someone who does own it, and then selling it the same way you sell normal stocks.
The short seller pays interest on the market value of the stock borrowed, and has an obligation to return the stock at some later time by buying a stock to close the position (cover). There are usually also collateral requirements.
Unlike options, there is no time limit to when the position needs to be closed. However, brokerages can close your position for you if they get nervous (e.g., if the stock goes up a lot and the brokerage does not think you will be able to buy back the stock in the future).
I like to think of short selling as synthetically creating a new stock-antistock pair from the ether (the ledgers of the financial systems or whatever) using energy (money). Basically, if there is a lot of demand for a stock (prices are high), then enterprising individuals who think a profit can be made can just artificially create a stock out of nothing to meet that demand, but that process also unavoidably creates an equal and opposite obligation to return that stock (because some kind of "law of conservation of stonks"). A stock and antistock can then be annihilated by bringing them together (closing the short position) to release money. Alternatively, you can think of short selling as time traveling: the short seller buys the stock at some future date, the stock travels back in time to allow the short seller to sell it today. These analogies are not particularly useful or elucidating, I'm just rambling to meet the word count requirement that my editor gave me on this post on my own personal blog that I completely own.
If the short interest (the total number of shorts sold) is high, it creates a volatile situation where many shares are owed compared to the number of shares available to sell. The short interest is often compared to the total number of shares issued or the public float (of all the stocks for a particular company that exist, only some are actually available for purchase on the public market, others are locked away via ownership by insiders) as a percentage, but this is somewhat misleading. (For simplicity, I'll stick with the total number of shares issued.) If the short interest (X) is higher than the total number of shares issued (Y), it does not imply that it's impossible for the short sellers to cover, because the total number of shares owned is actually X + Y (the short sellers created/sold new shares to new owners).
Still, though, the higher that ratio is, the harder it is for short sellers to unwind their position.
Squeeze
In a volatile situation where the short interest is high, an increase in the price of the stock can lead to a run-away process where price increase begets further price increase. The initial catalyst could be anything, like some sudden change in the company's outlook, or the short sellers collectively realizing they are screwed. As the price increases, the collateral requirements and interest rate for the short sellers increase also, so some of them give up and begin buying the stock to close out their position (at a loss), which drives up the price even more. This chain reaction can result in the stock price temporarily increasing by several multiples.
Gamestonk
So the short interest for Gamestop had been high for some time, exceeding 100% of total number of shares in existence. This by itself doesn't create a short squeeze: if everyone agrees that the company/stock is a piece of shit and the shorts are justified, then the price continues being where it is or declining (giving the short sellers a profit). But a few things happened:
Michael Burry (Christian Bale from The Big Short) bought a bunch (2- 3%) of GME shares, noting that 90% of stores are cash flow positive (August 19, 2019)
- Ryan Cohen (an ecommerce founder/executive with a successful exit (chewy.com, which sells pets toys online)) bought a bunch (~10%?) of GME shares (August 31, 2020)
later writes a letter to the board basically saying he thinks there is a lot of potential in the company and outlining his strategy for turning it around (November 16, 2020)
is eventually appointed to the board of directors along with some of his lieutenants (January 11, 2021)
People on wallstreetbets (a reddit subforum) get excited/retarded and jump in on the stock (happens gradually over a long time frame)
The Bull Case
Ryan Cohen's thesis is that Gamestop should pivot away from the declining, unexciting business of being a traditional brick-and-mortar retailer that is its legacy to pivot into building out a growing, glamourous, cash-printing digital experience/ecosystem as the core of its business going forward. This would reflect the reality of where gamers/dollars are going today. Whether this can be pulled off remains to be seen, but Cohen has the right experiences/credentials to get investors/management hard about the potential of him leading such a transformation, and his board appointment indicates Gamestop's willingness to move in that direction. It's not out of the question to think that Cohen may become the CEO of Gamestop in the near future. Regardless, Gamestop seems committed to the strategy he outlined.
So, there is some plausible case to be made that Gamestop's stocks are undervalued, and may be worth more in the future.
The Basket Case
Wallstreetbets is a subforum of Reddit where people go to lose brain cells. Well, first you lose the brain cells, then you lose your life savings. I mean, it's the internet, so you can never believe what people say... but almost certainly some of these people actually are maxing out credit cards to jump into meme stonks (and I support their right to be retarded). Still, theatre or not, it's pretty entertaining to read, and occasionally someone knowledgeable comments and you could learn something about the stock market (but... mostly just memes).
WSB isn't some kind of cabal of conspirators (they don't have enough collective brain cells to organize a conspiracy) -- it's more like a headless horde of zombies (zombies of below average mental faculties). Sometimes things become a meme and sometimes they don't. For whatever reason, GME captured the WSB collective to become the meme of the month. Of course, it has since blown up in mainstream media due to the stock price 10xing over the course of a few days and also the narrative of retailers vs hedge funds, but before then it was just something a relatively obscure corner of the internet made gifs and dumb jokes about, and before then it was just something that a few members talked about. One of the (the?) first redditors to start buying GME is DFV, and he was derided for being an idiot before everyone eventually came around and piled in on the stock.
Why did people start piling in? Probably because eventually GME started trending up. But it probably wasn't WSB that caused this -- as late as July 2020 DFV was still posting loss porn on GME (and getting called an idiot), but it turned into profit porn in August, maybe because of Ryan Cohen's actions. It seems that at that point GME reached a tipping point and more and more people began to buy into the bull thesis. At that point, WSB served like something of an amplifier. It gave the idea more visibility so more and more people became aware of the situation and an increasing fraction of them decided to jump on the bandwagon, for lulz, FOMO, personal gain, or whatever. But not, at least at this point, to screw over hedge funds.
So the first point I wanted to make is that WSB did not collectively decide to do anything. People were in disagreement until some kind of tipping point arrived and then groupthink became stronger and stronger. The second point is that WSB did not collectively decide to jump in on GME to fuck the hedge funds. The GME hype train was well in motion before the anti-hedge fund undertone became the headline. If you read those earlier posts, nobody is talking about Melvin or Shitron (some of the funds/people that shorted Gamestop). But today, you can't wade into WSB without bumping into a post or comment that talks about holding the line or make the shorts bleed or whatever.
In other words, I don't think WSB "caused" or was the initial catalyst for the Gamestop short squeeze (if any -- the situation is developing), but as an online watering hole, it allowed people to exchange ideas and was instrumental in building up the Gamestop situation to where it is today. So,
Technology is enabling more people today to become more knowledgeable about and participate in investing and the stock market. This is driven by mass adoption of investment platforms like Robinhood and Webull, 0 commission trades, and the ease of looking up information online.
Given 1, the dynamics of how stock trends play out are more affected by group dynamics of online social networks, which is very different from before, because people are more connected, anonymous, etc. (groupthink/echo chamber effects seem stronger)
Retailers vs the establishment is more of a post-hoc rationalization than a driving force in building up the Gamestop phenomenon to where it is today.
Effect Of WSB On The Real World
Evidently, WSB has had a big effect on the media, but it's not clear to me that it had or has that much effect on the actual price of stocks. WSB reached 2 million subscribers sometime in the week of 2021-01-18 (MLK day); today (2021-01-30) it has 7 million. Of 2mm subs, lets say 10% actually held GME stock (today it might be higher, but I think 20 is generous for pre-2021 -- also, 2mm is how many people joined, the daily active users count will be much lower), and maybe the average number of stocks per person is 10 (some people do take large positions, but there are also a lot of students/BA-degree-holders), so 2mm shares out of 70mm. It's not nothing (around Burry's share), but I don't think it's enough to start a short squeeze. This is just conjecture, but I'd guess that other hedge funds or investors (like Burry/Cohen) are more likely responsible for having driven the initial ramp up (perhaps after having been alerted by/observed the action on WSB).
Today, it's less clear. People who have never used reddit a day in their life are probably buying GME due to the media coverage, but they are also more likely to abandon the stock at the first sign of trouble (the technical term for this sort of person is a "paper-handed bitch"). Retail might be having a substantial effect on the price movement today.
Self-fulfilling Prophecy
After Cohen was given a (few) board seat(s) in early January, GME doubled in price from ~$20 to ~$40 over the course of a few days. It was around this time that your correspondent decided to hop on the bandwagon (bandrocket) and put some money into GME.
I decided that short squeezes were self-fulfilling prophecies. If everyone thought a short squeeze was going to happen, then people would buy/hold, short sellers would cover, and it would happen. On the other hand, if everyone thought it wasn't going to happen, then it wouldn't. I didn't know if Ryan Cohen or the console cycle or whatever meant that GME was "really" worth $40, but during the short squeeze the valuation would not be determined by "market fundamentals" or "reality" but by the logic of the self-fulfilling prophecy, and as such it could go as high as people (collectively) wanted to. That (and the high short interest) convinved me that GME could be worth more. Also, YOLO.
There are three games going on: a game of chicken between the short sellers and short squeezers, and two prisoner's dilemmas, one for each group.
Timeline of Events
I started following the story a lot more closely since then. Here are some of the things I witnessed:
- Citron Research scheduled a live stream to explain to the world why GME was a shit stock that was headed to < $20. This caused the stock to dip a bit, but then they canceled it "out of respect" because they suddenly remembered that the US presidential inauguration, something that happens on the same date (*) every four years, was happening on the same day (2021-01-20).
Citron continued to delay the event, citing twitter hacks, eventually posting a video instead.
(*) unless it falls on a Sunday.
- 2021-01-22 (Friday), all shit breaks loose. GME spikes to ~$70 during the day, finishing at $65 in what some describe as a gamma squeeze.
All call options finish in the money.
- 2021-01-25 (Monday), all shit breaks loose. GME hits 159 during the day, trading is halted multiple times (stock exchange circuit breakers). My brokers have technical difficulties and it is difficult if not impossible to place trades for any securities (not just Gamestonk) (doesn't seem like their system was able to handle the volume of traffic, at least during the morning hours).
- 2021-01-27 (Wednesday), all shit breaks loose. GME hits 380 during the day, trading is halted multiple times. My brokers have technical difficulties.
- 2021-01-28 (Thursday), all shit breaks loose. Robinhood suspends trading of GME (as well as a few other WSB favorites), allowing users to only sell but not buy the stock.
Multiple other brokerages also place restrictions, including Merrill Edge, Schwab, and Webull.
GME hits 480 in the morning, then dives to 112. Trading is halted multiple times.
- Throughout the week, politicians and billionaires tweet about the stock. Congressional hearings into allegations of market manipulation are proposed.
WSB goes from 2mm subs to 7mm subs, is made private multiple times as mods struggle to cope with the volume.
The Sheriff of Nottingham
Robinhood... oooh boy those guys are fucked. I mean, I know my mind immediately went to the conspiracy theory explanation:
Robinhood routes most of its orders to Citadel Securities (a market maker), which fulfills the orders.
Robinhood actually gets paid by market makers for this order flow. Since one of its core features is 0 commissions, payments for order flow and giving you a shitty interest rate are how Robinhood makes its money.
Payments for order flow is already a controversial topic as it potentially poses a conflict of interest.
Citadel (a hedge fund) bailed out Melvin Capitol by investing money in exchange for future revenue share. (So Citadel has an incentive to see Melvin make it through the short squeeze.)
Citadel and Citadel Securities are not the same entity, but... they are basically like different organizations of the same company (both are controlled by Ken Griffin, share the same building, etc.). If you ask a trader, they will probably tell you about the firewall that exists between these types of organizations and insist that nobody would be stupid enough to do anything untoward like have your market maker manipulate the market so as to give your hedge fund an edge because it's all kinds of illegal, but of course a trader would say that...
I don't have any sources/concrete examples atm, but it definitely seems to me that anytime someone is explaining the Chinese wall, it's in the context of "here is something that looks bad, because it looks like there was a conflict of interest and some institution breached the firewall and acted unethically for their financial gain per their incentives, which would be super easy to do because it's not like people outside these institutions have oversight, but don't worry it couldn't have happened because that's not how things work -- we have a firewall!" It's never "hey check it out these guys lost a whole bunch of money and now they're bankrupt -- guess the firewall was working!"
Take the Robinhood fiasco. By blocking buys but not sells, Robinhood biases the market towards lowering Gamestop's price (and that is exactly what happened on Thursday). Many retail investors don't have very strong conviction in GME and would panic sell if they see the stock dropping as volatile stocks are wont to do sometimes or if they saw a youtube video/TV segment/talking raven tell them to sell (these are the aforementioned paper-handed bitches). Normally this would be countered by another segment of retail investors that for whatever reason (delusions, a misguided sense of loyalty towards a cause like sticking it to the hedge funds which is a post-hoc narrative as we discussed, financial illiteracy, having a stroke, etc.) decide to HODL or buy, but Robinhood's actions means that they won't be able to. This would drive Gamestop's price lower. Also, the restriction affects Robinhood customers only, it's not a market-wide pause like exchange based halts, so those that sold on Robinhood, would be selling directly to institutional actors such as the hedge funds that overextended themselves on shorts.
In other words, whatever Robinhood's actual motives were, the concrete effect of Robinhood's trading restrictions are beneficial for short sellers such as Melvin, which Citadel has a direct interest in protecting. Immediately, allegations sprung up that Citadel/Ken Griffin pressured Robinhood to make these changes.
On the other hand, here is an alternative explanation:. TLDR is that Robinhood needs to post margins with the NSCC. The margins are to counteract against the risk of trades not being able to get properly settled (like, say, if someone were to buy a share of stock that's been heavily shorted and therefore is hard to find, and then that share couldn't be delivered because the stock has been heavily shorted and therefore is hard to find), and depend not only on the price and volume of the stock (of which GME is probably comparable to e.g. AAPL), but also its volatility (guh) and what fraction of Robinhood's total volume the stock makes up (guh). Due to the volatility and high price, Robinhood didn't have enough capital on hand to meet its margin requirements.
This theory is supported by the fact that Robinhood raised 1bb new capital Thursday night and is reported to have drawn down its credit lines.
Regardless of what the truth is, sentiment is low. People are angry! (Incidentally, I saw a lot of people railing against Robinhood on Blind, but no Robinhood employees commenting on any of these threads. Maybe they're all polishing up their resume.)
(At some point, AOC and Ted Cruz both tweeted their support for investigating Robinhood/the events of the week. I think this is a sign that Robinhood probably did not act nefariously -- only the honest and the stupid piss off both sides of the aisle.)
Assuming for the time being that not being able to meet margin requirements are why they imposed trading restrictions on GME (never assume malice when incompetence will suffice etc.), Robinhood pretty much handled things in the worst way possible.
The initial messaging positioned the move as "protecting the investors", which predictably pissed all of Robinhood's customers off.
I'm not sure how wide the messaging was. There was no email. Was there a megaphone? Some people may have found out by seeing the "Buy" button disabled in app.
Robinhood's founder only started doing interviews after there was significant backlash and everyone believed that Robinhood had made these changes at the behest or for the benefit of Citadel/the establishment.
The founder publically claimed Robinhood had no liquidity issues, which we now know was probably false (and contradicts the margin explanation (the explanation where Robinhood isn't evil)).
What Robinhood needed to do was get out in front of the messaging and control the narrative. Thursday morning, the founder needed to have hit all the TV shows/social media and given a reason that doesn't smell like bullshit. Instead, Robinhood asymmetrically restricted trading with minimal and poor messaging, there was predictable backlash and people jumped to conspiracy theories (or are they...), forcing Robinhood on the defensive.
Probably, Robinhood acted the way it did because it was concerned that admitting Robinhood had a liquidity issue and was having trouble meeting the margin requirements would trigger a mass exodus of customers who thought they might not get their money back (another self fulfilling prophecy). In hindsight, they should have been more concerned about the optics (and reality?) of market manipulation. Maybe if they admitted posting margin was a problem, it would have gone better (but maybe not -- as far as the customer is concerned, it's not really their problem, the brokerage should just figure it out). Maybe there was a way to message the whole thing that prevents both a withdrawal run and conspiracy theories/mass outrage. Or maybe there was a way out of their pickle without placing trading restrictions at all (unlikely -- Ken Griffin and his baseball bat are very convincing).
Regardless, the way it did play out, Robinhood lost the confidence/drew the ire of exactly the demographic of users it's catering towards. Maybe it will blow over (there was some kind of outage a while back where you couldn't trade for like two whole days, and then that FINRA fine thing -- how many people remember those?). At the very least, the IPO probably is going to be a dud (people were so excited just a few days ago). Personally, I think this is the end for Robinhood. I'm certainly in their targeted demographic, and I've decided to take my business elsewhere.
Robinhood's Replacement
I (and probably a lot of people) signed up for Webull on a tip that they were still trading GME. I think at some point Webull also halted trading of GME, but they somehow escaped the masses' anger. (The CEO of Webull, Anthony Denier, claims that that Robinhood placed trading restrictions due to clearing costs and not due to Citadel pressure, but of course he would say that, his name is Denier. A different explanation implicating Citadel was proposed by his cousin, Anthony Confirmer.)
I was surprised to find that Webull's interface is pretty nice. It's way better than Robinhood -- there are more widgets and numbers and the lines come in different colors and so on. It seems they are taking a different approach to the UI. Features wise, you can trade during extended hours and participate in IPOs (not every IPO is available, it depends on if the underwriter will throw some bones to Webull).
Fidelity and Vanguard were two other brokerages that did not restrict trading of GME and I also opened accounts with them. Fidelity also gives you access to (select) IPOs, but only if you have a lot of money. Vanguard I think gives you lower expense ratios on their ETFs (if you have a lot of money).
Where We Are
By some accounts, throughout most of the week's antics, the shorts had not covered. (That graph looks like they did cover a bit towards the end of the week though.) It was surprising to me that the short interest remained elevated at the beginning of the week (since I thought a short squeeze was going to happen), like what the hell are these guys doing, don't they know they're going to get burned? But I suppose the short sellers are thinking the exact same thing about the short squeezers. Also, maybe some short sellers got out and new ones (or the same ones) piled in. After all, if you were willing to short the stock when it was < $20, you would much more happily short it at $200.
Parting Thoughts
The biggest loser of the Gamestonk phenomenon was Robinhood (and some hedge funds)
The biggest winners were Webull et al (and some hedge funds)
Retail investors: depending on how early they got in, some are winning and some are losing. Some will be left holding the bag
Politicians will use these events to expand their influence in a way that is basically orthogonal to what actually happened
Institutional investors may start paying more attention to what WSB are piling onto, or sentiment on Reddit/social networks in general. It's not clear how much signal you can extract here. For every Gamestonks, there are probably dozens of failstonks that come out of WSB. However, it's not important or even desirable to get in early -- DFV started going long GME in like 2019, but you could have jumped in at the beginning of 2021 and made some quite good returns. You could just invest in whatever is popular at any given point -- I'm kind of curious to try this out...