Anyone who has been keeping up with the stock market news must have noticed the stock price of GameStop skyrocketing in the past few days. It is strange enough considering that GameStop is now an artifact of the past which is now, according to many, breathing its last breath. The fact that a bunch of Redditors are responsible for it all is even stranger. Let us go through the series of events that led to the current scenario and try to understand why and how it happened.
How It Started
It all started r/WallStreetBets when an influential user realized that a massive amount of GameStop stock was being shorted. As a matter of fact, it was the most shorted stock on the US markets. Now before continuing let’s explain what is Shorting a stock.
Shorting A Stock
When a person buys a stock he is basically betting for the stock of the company to go up in value. If the value goes up the person can sell the stock for a profit. But what do you do if you think a company’s stock is going to lose value i.e. GameStop. Well, what you can do is “short” the company. In order to short a company, a person borrows stocks at the current value of that stock. Now pay attention as the person is borrowing the stock meaning he has to return the stock he borrowed. Then the person sells that stock. As he expects that company’s stock to drop, he intends to buy the same amount of shares he borrowed when the price of the stock goes down. After buying the stocks back on the reduced value he then returns the stock and keeps the difference thus profiting.
I’ll give you a hypothetical example. Let’s say a person expects the stocks of DELL to drop in value. He borrows 50 shares of DELL at the price of 100$ per share (5000$ for 50 shares) from a broker and sells them in the market. Now he has 5000$ and he owes the broker 50 shares of DELL. As he expected the price of a stock goes down to 50$ per share. So, he can now buy back those 50 shares at the reduced price of 2500$. Now, buying back those 50 shares only cost him 2500$. This means he now has 50 stocks and a profit of 2500$. He gives back the 50 shares he owed to the broker and keeps the difference/profit of 2500$.
Another thing to note is “short squeeze” which is when the person borrows and sells the shares to “short” but the price goes up instead of going down. So, he has to buy back the higher priced stocks to return them to the lender. This results in the person who is shorting having to use even more money to buy back the shares and thus losing money.
For example, a person borrows and sells 50 shares of DELL at 5000$ but the price instead of going down goes up to 200$ per share. Now, he has to buy back the 50 shares at 10,000$ to return the 50 shares he owed. In this case, he had to spend 5000$ out of his pocket to buy back the shares thus losing money
What Happened Next?
As mentioned before investors saw that GameStop is a dying business so they shorted it. Upon discovering this a large amount of Reddit users decided to buy stocks of GameStop to increase its value and thus trigger a “short squeeze”. The reason why Redditors did so, according to themselves, was for profit and to just make the rich lose money. And that’s what happened. GameStop’s stock value rose and those who were shorting the stocks suffered massive losses an example of which is Melvin Capital hedge fund.
What Is Going to Happen?
As Redditors have decided to hold the stock instead of selling the prices are soaring while those who tried to short squeeze GameStop are suffering losses. Redditors are also looking at other stocks such as AMC and Blackberry etc. to try and do the same. All of this is bound to blow up and when it does it is going to blow up big!