From GameStop stock to Game of Thrones!
I thought I have seen everything in my life in 2020 starting from Nifty falling from 12K odd to 7.5K and going back to 13k+ in the same year, oil going into negative territory, Fed printing unlimited money, and whatnot. But I never imagined retail investors blowing up a big hedge fund like Melvin Capital.
So what’s the GameStop stock story – who did what?
The story is simple! Melvin Capital, which is a big hedge fund in the US took a big short position on a company called GameStop whose primary business is to sell gaming consoles and video games. Since the start of the COVID situation, the company was struggling to manage its finances and there were rumors about the company going to bankruptcy because of this.
Melvin Capital thought they found a treasure and shorted Game Stop stock aggressively to the extent that the short position on the Game Stop stock was way beyond its free float shares.
It’s not unusual for this to happen in the US, Normally hedge fund managers identify weak stocks which are on the verge of going down, short the stock, and cover the short when the stock goes down! A sweet simple money-making machine!
If someone told me that a Reddit group can take down a big hedge fund like Melvin Capital then I would have taken that as a good joke! But the subreddit group called wallstreetbets found a gold mine when one of the group member noticed that the Game Stop stock was heavily shorted to an extent of 140% of its free float shares already!
back in September 2019; Someone named ‘DeepFuckingValue‘ posted this on r/wallstreetbets: https://www.reddit.com/r/wallstreetbets/comments/d1g7x0/hey_burry_thanks_a_lot_for_jacking_up_my_cost/
The initial post talked about how the short position on the stock is way beyond what it should be!
A year later and people started to take notice on Reddit. After getting this info then subreddit members circulated messages to buy the Game Stop stock and take delivery of it. They knew that the short sellers have to eventually buy the shares at a later stage and since the shorts are more than the free float available there is a scarcity of no of available shares to purchase.
The price has started inching up, from $4 to $8 to $12 over September and October 2020. And more people on Reddit started buying in. And then more people. And then more people.
This makes the price of the GameStop stock to go up. So the price keeps going up and more people keep taking notice and so on. Eventually, the shorts are supposed to cover. But how? They need to purchase more shares than there are in the company. Well, that means purchasing at any price. This is called ‘Short Squeeze’
This pushed the price of the GameStop stock to skyrocket, The retail guys were lapping up the stock and the short sellers were forced to buy the stock to cover the short position this meant hundred and thousand of buy orders came in for the stock which made the stock price to skyrocket! So a sub $10 stock in 2019 is worth $400+ in Jan 2021.
As of 29th Jan 2021, according to media reports – Melvin capital has closed its short position on the GameStop stock and it’s understood that there is a capital infusion of around 2.7 billion dollars to make this happen. Although the exact loss figures for Melvin Capital is not ascertained but its speculated that the loss for Melvin capital will in billions of dollars.
There are also reports that popular trading apps like Robinhood brokers have limited the purchase capability of retail investors from their platform because of the volatility of the GameStop stock.
Can there be a GameStop stock moment in India?
The GameStop stock episode has brought a lot of attention all around the world and people have started thinking whether something like this can happen in India as well.
Nithin Kamath, CEO of Zerodha brokerage firm tweeted on this subject and said that there are strict regulations in India that makes sure that GameStop stock-like event can not take place in India because of the strict regulations followed. Here are some important points from the tweet.
Important lessons from the GameStop stock short squeeze
There are enough lessons to be taken from the GameStop stock saga.
- Never short a stock beyond a certain limit
- Like retail investors, Hedge funds can blow up!
- Never short-sell a stock if you don’t understand the ramifications
- Retail investors can take down big hedge funds! – Power of social media!
Disclaimer – The view expressed here are collected from my readings on various social media platforms and is my personal view. Readers are advised to consult their financial advisor before making any investment decisions!