$GME: The Fight for a Free Market

$GME, A movement months in the making from people on the political left and right, their leadership amorphous, united under a common theme of populism: Takedown the big bad guys. 

Mandatory disclaimers:

• To keep this article concise I will have to gloss over many technicalities and specificities (for instance, Reddit users using public information and scrutinising hedge fund portfolios and balancing methodologies).
• Please note that this is not financial or legal advice, please do not treat is as such. This is my attempt at explaining the financial movement we are observing.

Before we get into the story, let's cover some technical terms:

‘Short selling’ is an advanced trading strategy that speculates on the decline in a stock or other securities price. So in effect, they would ‘borrow’ stock from a stock owner and sell it to the market in hopes that over time the market value of the stock depreciates so that they can repurchase it for a lower price and return it to the original owner. Here, the difference between the higher selling price and lower ‘buy-back’ price is the profit.

For example, a trader sells 'short' 1 share of Corp A at €10, based on the opinion that the price of those shares will head lower. When Corp A’s shares decline to €5, the trader buys back the shares to cover the short position, getting a profit of €5 (selling price – buying price).

This is considered an advanced strategy because unlike buying a stock, where the maximum loss you can suffer is the price dropping to zero (0; the price can increase exponentially causing a short-seller to buy back at a much higher price. For instance, in the example above if the price increased to €500, the trader would be forced to buy the stock back at €500 and suffer a loss of €495. In other words, a short-sellers loss can theoretically be infinite (as the price increase). In addition, traders shorting a stock are required to pay interest for the duration they borrow the stock.

‘Short interest’ is the number of shares that have been sold short but have not yet been covered or closed out. Think of this as someone borrowing a stock and selling to the market. Then, instead of repurchasing it, they proceed to borrow another stock and sell it to the market. This generally drives down the price of the underlying security. Short interest, which can be expressed as a number or percentage, is an indicator of market sentiment.

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Back to the movement:

In 2012 a subreddit was made for users to share ridiculous - once in a lifetime - trades they participated in. Millions earned and lost in a matter of second. The platform did not provide trading advice, it does not organise collective trade; it only asked thrill-seekers to share their adventures.

On this subreddit, some users noted that the publicly traded shares of GameStop Corporation (NYSE: GME) had a short interest of over 100% (currently ~140%). This meant that every stock that was publicly traded had been shorted at least once – in this case, 40% over - without the traders (‘short-sellers’) repurchasing the stock to close their positions.

These users theorised the following: should there be a sudden demand of this company’s stock, the price will increase and the increase in price will result in a loss for the short-sellers who had yet to close out their position. They further theorised that if people trading these stocks decided not to sell back to the market and simply hold the stock, the short sellers will find it hard to buy back shares at a lower price and be forced to pay a much higher market price to finish their trade. This loop is better known as a ‘short squeeze’. A similar loop exists in the world of options (another financial instrument) trading, however, here this process is known as ‘gamma squeeze’.

These users further theorised that with an increase in the price of shares in addition to a lack of supply of the associated options the price of shares and its corresponding options could easily 10x or even 20x since short-sellers would be forced to buy limited shares over and over at higher price each time to fulfil their trade.

Brilliant!

But there's a monumental challenge, to realise this idea, they needed a collective effort from numerous individual traders (also known as retail investors) - the kind Wall Street had never seen before. People were not only expected to buy GME stock to increase the price but also hold their position through any volatility.

Now, if you have worked on any group projects, you know how difficult it is getting a group together. How did these users ever reach consensus? As is often the case, some hope, some hate and the possibility to make a lot of money.

1. Some users shared their due diligence and noted that the hedge funds and traders short-selling the company were doing it intending to drive their value to nothing and possible bankruptcy and that they had done this to various other companies.
2. Some users shared that there was hope for GME in the long run with new management in place.
3. Many users who understood the technicality were driven by the profits that could be made.
4. And of course, in line with the spirit of the forum, some users joined in for the ride - because why not.

This sparked a colossal positive momentum. As more (non-Reddit) traders saw the momentum, they decided to join. Between January 1, 2021, and today, GME has seen an increase in the price of nearly 2000% - from $17 to nearly $350 with levels of volatility that may put Bitcoin to shame. Over the same period, two main short-sellers closed their positions with massive losses. However, the remaining short-sellers decided to double down on their call and continue shorting the stock despite the increase in price. To make matters worse, trading platforms such as Robinhood are limiting the purchase of GME and other stocks, the media is portraying the retail investors in an increasingly negative light and asking for regulations.

This added more fuel to the fire. To retail traders, this call for regulation or platforms restricting trade in a free market is akin to suppression of the 'little guys' who are beating the 'whales' at their own game. Following GME, traders across the world are now rapidly buying stocks of companies that are shorted heavily - especially companies that over shorted. We are seeing 200%, 300%, 400% growth on stocks of companies that were months away from bankruptcy. This movement may be the blessing that traditional brick-and-mortar companies needed to survive in this pandemic.

No one knows how this situation will play out. No one knows if a 'short squeeze' will ever arrive. What we do know for sure is that this is no longer about the GME stock. This movement has caused hedge funds across the globe to close their positions and revise their trading methodologies. This has now turned into a tug-of-war between billion-dollar hedge funds and retail investors.

What is my take on all of this?

In the words of Chamath Palihapitiya, ‘technological innovations are levelling the playing field for institutions and retail investors’. All of this was facilitated by technological innovations. Open forums allow for transparency far higher than what most institutions operate at and enable each user to do their research and make their own decision. Trading platforms have now made it easier than ever to get involved in the financial markets. Real-time market data is available at as low as €2 per month.

I have been positively overwhelmed seeing screenshots of users posting photos of student loan repayments, cheques to family members in need and covering emergency medical costs. It also makes me unhappy to see that there is a sudden call for regulation and restriction on trade when the general public is using the same methodologies as hedge funds and following rules of momentum trading. At the same time, I worry about the spill-over effect this will have on all the people that choose these funds and the market as a whole.

For now, I am simply happy being a part of this historic moment.