Won’t Stop, Can’t Stop, GameStop

By Derome Robinson, Timothee Roques and Sam Richardson Analysts at the LSESU Trading Society

The aging retailer GameStop has gathered worldwide publicity this week after unprecedented levels of volatility with a daily volume of 177 million shares on January 25th, topping the NYSE and reaching prices the company has never seen. Opening on Monday at 96.73 USD, the GME stock gained traction by reaching levels of 483.00USD when the US market opened on Thursday. Due to such levels of volatility and lack of liquidity in online brokers, companies such as Robinhood had to restrict trading stocks such as GME, BB and NOK. This created controversy on social media as retail investors accused Robinhood and other platforms of market manipulation and is now facing several lawsuits from individuals, to deepen the wound, U.S politicians by the likes of Elizabeth Warren (United States Senator for Massachusetts) have called on the SEC for an investigation into market manipulation on both sides of the tug of war.

But how did this start?

Ryan Cohen is the co-founder and former CEO of e-commerce company “Chewy” and last year he took a large position in GME (12.9% stake). Earlier this year GameStop then announced that Ryan would be taking a board seat at the company. Many investors viewed this news with optimism, arguing that GameStop may be able to exit their struggling phase with a shift to e-commerce with the help of Ryan’s expertise. With added buying pressures and a willingness to buy GME shares at a higher price, the stock inevitably started an increase in value.

The world is facing an economic crisis with many ordinary people losing their jobs and being forced to stay at home to prevent the spread of COVID-19, as part of a stimulus package in the US, people received $600 checks from the government to encourage spending which would support the consumer sector. However, this took an unprecedented turn when retail investors on the internet forum ‘Reddit’ identified an opportunity in GME.

U.S hedge fund, Melvin Capital, had been short selling GME shares at absurd levels with a short interest of 149% whilst GME was priced at around 15 USD in late 2020; retail investors realised they could counter this strategy by buying shares of GameStop and induce a ‘short squeeze’.

What is a short squeeze?

First, we need to recall what shorting really is:

Step 1) Borrow the stock.

Step 2) Sell the stock

Step 3) When the price falls, buy the stock back and return it to the lender.

So, a short squeeze is when a price rises instead, rising so much that the short sellers are forced to cover their positions by buying back the stock at a higher price, pushing the bar even higher after.

Due to the rise of these retail investors, short sellers have incurred an estimated loss of $19 Billion so far and the worse is not over. Short selling puts the seller at infinite risk with limited gains, short selling can make profit but when done with caution and risk management.

Source: IG Trading Software

As GME stands, online brokers face very limited liquidity as retail investors hold their positions in anticipation of a gamma squeeze, a very rare movement of price and far more damaging for short sellers than the typical short squeeze.

When traders are buying options, the ‘writer’ of the option must cover their position if the contract is exercised by the buyer. The writer is a market-maker, someone who buys and sells assets in the financial markets to create liquidity which allows trades to be completed without cancellation.

Because these market-makers are putting themselves at risks when selling these options (in GME’s case, predominantly call options), a method to hedge against this would be to buy the underlying stock. A gamma squeeze is when market-makers use this hedging strategy and they buying pressures cause the price of the stock increase. This is not the first time a stock has been gamma squeezed, the Volkswagen stock (VW) experienced the same upward pressure in 2008, leading to a sharp and very narrow peak. Retail traders believe GME has more potential since the stock has a 6 Days to Cover Ratio, meaning it would take short sellers 6 days to close all of their short positions and the current short interest of 113% suggests it is not over.

Source: Financial Times

As it stands, the continuous buying of GME is putting pressure on broker’s liquidity which could create a chain effect on the rest of the financial system, should the retail investors hold.

So what does all this mean for markets?

Firstly, an important factor would be the power of the retail investors. With their united actions, they have been causing a lot of trouble for the big institutional players, this would’ve been unheard of ten years ago and it goes to show the slight changes in the market dynamics. Factors such as: commission-free trading, FOMO (Fear of missing out), stimulus checks and being forced to remain at home have caused a massive inflow of retail investor’s capital into equity markets. Also, it is important to recognise that some retail investors are very experienced in the world of trading and the stereotype of ‘dumb money’ perhaps should be scrapped.

After recognising the short interest of 149% and low share price, retail investors went on to promote nostalgic stocks with similar properties such as BlackBerry (BB) and Nokia (NOK), leading to volatile market conditions for a wide variety of different stocks.

However, despite all this. It’s still hard to determine whether the new market dynamics are here to stay. Will these freelance trades, overvalued stocks and borderline gambling soon meet an end and bring retail investors with them? Or will the presence of retail investors be a new norm that we all need to adapt to.

In Game Theory, we could say that they were colluding in a way to fight against the establishment that is Wall Street, the problem starts when retail investors deduce their exit strategy, a sudden sell of GME could leave some retailers holding the bag if they don’t act fast, and the situation could be exacerbated if online brokerages freeze trading activity due to ‘volatility’.

In the next week we might see the conclusion of the GameStop saga in which the climax may be too fast for anyone to really see.

Overall Market News

If GameStop’s situation was on every investor’s mind during this chaotic week, regardless of their trading experience, many other factors have upset the equity markets. Despite being a promising recovery week, with the presidential handover operating smoothly after the Capitol’s frenzy ended, and the fiscal stimulus arriving in due time to raise inflation after a low 1.4% inflation rate in 2020, the many remaining uncertainties led to a pullback in most major indices, with S&P 500 losing 3.7% of its value in 5 days.

This can be attributed to the GameStop events which are most likely to highly impact the equity market in the upcoming week, and the arising of new COVID-19 variants in the UK and Brazil, and to the unpredictability of an additional $1,400 stimulus check on top of the previous $600. It is also important to point out that an increasing inflation will ultimately lead to long-term interest rates being raised, thus hurting the value of holding long-term assets.

The UK also witnessed a significant hit to its beloved FTSE100, with a 4.2% pullback in a week, as lockdown continues to freeze the economy. Their neighbour, France testifies to significantly different concerns, as the ineffectiveness of their vaccination campaign and the idea of an interest-free loan for the 18 to 25 settling in the public debate pull the CAC 40 down just under 5,400 € for a 3.3% loss this week, the worst in the past 3 months for this index.

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