GameStop stocks see instability as Redditors challenge hedge funds

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A subreddit called r/wallstreetbets had talked about GameStop’s stock in past years. In the winter of 2020, however, retail investors began buying up the company’s stock.

As we enter the second stage of GameStop’s Wall Street drama, we may forget the truly ridiculous ride that led us here. The GameStop short squeeze is a story with multiple characters: a hedge fund CEO, an investor app, a corporation potentially on its deathbed and retail investors.

The Deathbed Corporation

The story begins with the corporation GameStop. GameStop is an American chain of brick-and-mortar video game stores. For years, GameStop allowed gamers to trade-in games they no longer played for small amounts of cash or in-store credit. However, GameStop faced struggles in recent years due to consumers’ increased taste for digital distribution. 

According to Statista, physical game sales accounted for 80% of total sales in 2009. In 2018, digital game sales increased to 83% of total sales. 

The change in consumer tastes can be attributed to a variety of factors ranging from convenience to the expansion of high-speed internet. Regardless, this posed a severe risk to GameStop’s business model. 

Goliath and his Gamble

In 2020, GameStop’s problems were exacerbated by the COVID-19 pandemic. According to an unaudited balance sheet created by GameStop in May 2020, GameStop’s total assets decreased by nearly 33% from the previous year while their total liabilities grew. Hedge fund managers began to bet against the company. 

One of those hedge funds was Melvin Capital, founded in 2014 by Gabriel Plotkin. During an interview with Bloomberg, Plotkin stated the firm had an “intense focus” on short selling. 

Short selling is the practice of an investor borrowing shares of stock from a company and immediately selling them. This investor, known as the short seller, is contractually obligated to buy back the stocks by an expiration date. 

As with all investments, there is risk and reward. With the practice of short selling, the reward is in the value of the stock decreasing rather than increasing. In simple terms, the short seller hopes to borrow and sell a stock now then buy it back cheaper later. 

However, the risk can be extremely high. Certified Financial Planner Jay Peters, a strategy and allocation specialist with St. Louis based MSMF Wealth management, explained the risk. 

“If the stock price goes from $5 to $10,” Peters stated, “[the short seller] just doubled the money he lost.” 

Peters stated the potential losses short sellers could incur are unlimited. 

Before starting Melvin Capital, Plotkin worked for SAC Capital where he managed a portfolio valued at around $1.3 billion. Plotkin’s investment success translated to his newfound firm, which had returns over 40% in both its first year and in 2017.

Last year, Plotkin’s firm landed on the Polish Short Sale Registry because of a short position in the Polish game developer CD Projekt. The investment paid off after the game developer botched the launch of its highly anticipated game Cyberpunk 2077. Plotkin and Melvin Capital’s success paid lucratively, earning him $300 million in compensation in 2017 according to Forbes. In December 2020, Plotkin spent $44 million on two adjacent, beachfront homes in Florida. 

Melvin Capital was not alone in their bet against GameStop: a report by Investopedia stated the short position adopted by Melvin Capital and other investors accounted for a staggering 139% of existing GameStop shares, meaning some already shorted shares had been re-lent and shorted again. The doubling down on the bet against GameStop made its equity the most shorted in history. 

David Meets Goliath

In the first month of 2021, Plotkin’s Melvin Capital began suffering extreme and debilitating losses. By the end of January, Melvin Capital was down 53%. The cause of the firm’s quick and prominent downfall stemmed from numerous short bets that soured; the most prominent bet was short selling GameStop. 

But how could Plotkin’s bet against GameStop fail? How could a firm like GameStop, with a possibly outdated business model, rise in value so quickly? In every regard, it seemed to be more foolish to bet on GameStop than against it. 

A subreddit known as r/wallstreetbets, an online community on Reddit dedicated to retail investor discussions, had on-and-off conversations about GameStop’s stock over previous years. Some users had taken GameStop’s addition of Chewy co-founder Ryan Cohen to its board as an indication the company’s financials would turn around with the company. 

However, some Reddit users and other retail investors began taking notice of the short bets against GameStop. This is not some form of insider trading or heavily kept secret: information on shorted shares is publicly available on outlets such as Yahoo Finance. Reddit users realized the GameStop short was so extreme that they could force a short squeeze. 

A short squeeze is when the price of a stock starts to spike, causing short-sellers to quickly buy-back the stock before the contractually obligated date in an effort to cut their losses. A short squeeze can be instigated when increased demand for a stock causes its share values to rise.

Reddit user “Stonksflyingup” posted a video to r/wallstreetbets on Oct. 27, explaining to users that Melvin Capital’s short position allowed for retail investors to force a short squeeze. The user visually equated a short squeeze blowing up to the Chernobyl nuclear disaster by using a scene from Chernobyl. 

Quickly, sentiment grew throughout r/wallstreetbets to go through with the short squeeze. Redditors began buying and holding GameStop stock. These retail investors rallied behind cries that varied from “getting rich” to “sticking it to the hedge funds,” taking on the role of David. The confidence of GameStop’s failure by hedge funds was met by an equally confident Reddit user base. Users began to believe they could not lose.

On Jan. 11, GameStop had a trade volume in the tens of millions. On Oct. 27, the share price for GME was $12.69 a share and grew to $19.94 on Jan. 11. Reddit users still insisted the stock would “take off like a rocket.” 

And they were right. The stock price continued to grow at an increasingly larger pace. By Jan. 22, the trade volume was nearly 200 million, reflecting the subreddit’s enthusiasm. The stock price exploded from the $19.94 value to $76.79 on Jan. 25. Most investors would be more than happy with their gains, but Reddit users insisted they were on a mission to “send GME to the moon.” The Wall Street Bets subreddit sentiment was unanimous: keep buying and Hold. 

On Jan. 26, the stock value increased by an additional 92.71%. The next day it ballooned further with an increase of 134.84%. This placed GME’s net change up 131.4% on the year. If an investor purchased $100 of GME stock on Oct. 27, the day Reddit user Stonksflyingup posted his video, the investment would have been worth $1,367. 

Media coverage of the Reddit user base’s optimism was virtually non-existent from October to December of 2020. Coverage of the squeeze began by MarketWatch on Jan. 13, but Reddit’s financial plot was still largely under the radar. On Jan. 22, the GME stock price caught national attention and countless media reports followed chronicling the r/wallstreetbets involvement. Some commentators referred to the squeeze as the next “Occupy Wall Street” movement. 

To some of the Reddit user base, it was. Reddit users reported heavy investments into GME out of spite towards Wall Street. Some users told personal anecdotes about The Great Recession; others talked about financial hardships induced by the COVID-19 pandemic. The Reddit investors were split between those that wanted to be rich themselves, and others that harbored resentment towards wealthy Wall Street investors.

For Tim Hatten, a Missouri resident, he joined in after hearing about the squeeze from a third-party investor group. To him, he wanted money and social justice. 

“I’m here to get money and get out. The cause is nice, but that’s it,” he said. 

Hatten praised the retail investors’ efforts, insisting the squeeze helped regular people. 

“Empty bank accounts are being filled with thousands thanks to a coordinated effort,” he said. 

Sentiment from Reddit at the GME squeeze’s peak echoed Hatten’s sentiment. One Redditor and Missouri resident, Devin Sandlin, got into the squeeze after seeing the posts on Reddit. He wanted to use the squeeze to pay off his credit card debt. The squeeze allowed him to do just that during the COVID-19 recession. 

David beats Goliath? 

As the GME stock and Reddit user-base rallied, it looked like they were winning. 

“These guys getting on Reddit saying keep buying, keep running it up,” Peters stated. “They’re running these hedge funds into the ground.”

Many outlets published opinion pieces vilifying the retail investors and Reddit user-base, including the Washington Post on Jan. 30, which referred to the hedge funds as “the good guys.” Popular night show host Jimmy Kimmel also condemned the retail investors, calling them “Russian disruptors.” 

The coverage was negatively received on Reddit, and r/wallstreetbets users took this as an underdog challenge. It was “Us versus them.” 

The GME stock hit a massive peak on Jan. 27. Reddit celebrated as Plotkin’s Melvin Capital suffered heavy losses over the course of the squeeze. The losses were so severe that reports circulated on Reddit that Melvin Capital had been bailed out to the tune of billions of dollars. Plotkin would later deny these claims. 

At the height of the squeeze, Isiah Oesterlei, a financial research associate with MSMF Wealth Management, stated GME’s stock did not reflect real-world data and asserted the stock price would eventually come down. He called GME “one of the purest bubbles we will ever see in the stock market.” 

“There is nothing about the actual fundamentals of the company that in any way justify the stock prices,” Oesterlei said. 

The GME stock hit $400, and Redditors celebrated. Oesterlei referred to it as “one of the first cases of retail investors ‘beating’ Wall Street.” 

The Fall of David

But a new player entered the game on Jan. 28. Retail investor apps halted trading for GameStop and other stocks targeted by the retail investor groups in the short squeeze. The most prominent investor app in the saga was Robinhood.

The decision to halt trading immediately lowered the demand for GME stock, and it began to fall. As the share price plummeted, Redditors became furious. The halt produced a fallout they had not accounted for, still believing fully in the unwavering optimism of the squeeze. Some alleged a conspiracy at Robinhood. Multiple Robinhood customers filed class-action lawsuits against the company. Rapper Ja Rule called Robinhood’s actions “fucking illegal,” and comedian Jon Stewart defended the retail traders stating “[the retail investors are] joining a party Wall Street insiders have been enjoying for years.”

Furious Redditors and entertainers were not alone in condemning Robinhood. U.S. politicians such as Rep. Alexandria Ocasio-Cortez (D-NY) blasted Robinhood’s actions. Two state attorney generals, from Texas and New York, confirmed they would investigate the matter. 

Hatten questioned the ethics of Robinhood’s and called their decision to halt trading “Bullshit.” 

“Hedge funds have been doing this the whole time,” Hatten stated. “Why is it bad when we do it?” 

Robinhood’s CEO, Vladmir Tenev, would testify before the House Financial Services Committee on Jan. 28. Tenev defended his decision at Robinhood and the company’s role in the event and denied collusion with hedge funds betting against GameStop. 

The fallout from Robinhood and other investor apps’ decisions were severe. After hitting $400, the GME share price would fall to the $50 range by Feb. 5. Reddit users on r/wallstreetbets shared stories of total losses. Some mentioned losing their entire life’s savings during the fiasco. While Plotkin and Melvin Capital were potentially bailed out, these retail investors, everyday people, were not. 

Epilogue

To a degree, the GameStop/Reddit saga is continuing. While firms such as Melvin Capital closed their short positions back in January, r/wallstreetbets remained faithful to the cause and still plan to push GME higher. The result is GME remaining a volatile stock. The first squeeze has already green-lit Hollywood projects.   

While the memes may have been fun to some, the fallout had harsh financial effects on some regular people when Reddit users’ predictions failed. Jay Peters, warns future investors from falling into any craze when investing to protect themselves. 

“Plan for two things,” he said., “Have a plan of when to buy [a stock] and have a plan of when to sell.” 

Despite a single Congressional hearing, there has been no action taken by the government. Many lawsuits revolving around the GameStop saga are still pending, including some against specific Reddit users. Oesterliei stated he did not believe this squeeze would result in future regulation, but Peters was open to the notion the government may take some form of action. 

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Caleb Sprous
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