Melvin Capital’s advertised short interest in GameStop was worth more than $55 million. Besides the hedge fund, Citron Research, a company headed by activist short-seller Andrew Left, also had openly advertised short positions in GameStop.
With the pandemic hitting retailers the worst and online gaming gaining popularity, a company like GameStop that retails video games was most likely to meet a sorry end. That was the fate the short sellers were betting their money on, and one could say that their odds of winning were pretty strong.
REDDIT REVOLUTIONARIES, OR IDIOTS?
Enter the zero-commission trading app-wielding retail traders, which are part of a social media group on Reddit, called WallStreetBets, which at last count had more than 2 million members.
Few members of the Reddit community made a clarion call: they will take ‘GameStop to the moon’ by betting against the Wall Street hedge fund and other short sellers of GameStop. They pumped up the stock high enough to trigger a mind-boggling short squeeze.
A short squeeze is an event where the stock price moves up rapidly, forcing the traders who have taken short positions in it to cover their positions by buying the stock in order to cut losses. They need to buy the stock to honour the delivery of the scrip.
What started as an ‘idiotic enthusiasm’ (a term used by one Reddit member of the group) turned Wall Street upside down and left some of the biggest investing minds scratching their heads. At the high point of the day on Monday, shares of GameStop, which was sleep-walking to bankruptcy, had logged an eye-popping 779 per cent gain for January thus far.
“Hedge fund managers live in the past, and continue to look down upon the retail investors. They truly believe that we, the average retail investors, do not know anything about finances or the market (which may be true), and we’re just gambling our money away,” posted a WallStreetBets member with the pseudonym BenAffleks.
Other members of WallStreetBets bought the stock and its Call options in a show of solidarity and chanted YOLO — you only live once — as a mantra in their attempt to stage an audacious rebellion act against Wall Street.
And they succeeded, at least so far.
Late Monday, Wall Street Journal reported that Citadel and Point72 will bail out Melvin Capital by investing $2.75 billion in the hedge fund, after it booked nosebleeding losses in its short positions on GameStop. According to some reports, it was not in a position to honour the delivery of shares it had shorted.
Citron Research also took a heavy beating, as its short bets on GameStop were running a marked-to-market loss of nearly $2 billion. Some reports said short sellers in GameStop were sitting on year-to-date losses of more than $5 billion as on Wednesday.
On the other side, some of the option buyers of GameStop became multi-millionaires overnight. One member of the infamous group turned their $50,000 Call options into a goldmine worth $13 million.
The game of Russian roulette, however, is no longer limited to the ‘degenerates’ (as the members of WallStreetBets call themselves), as some billionaries have also hopped on to the gravy-train that is the post-Covid bull market.
On Tuesday, Chamath Palihapitiya, the billionaire owner of Social Capital and investor in companies like Slack and SurveyMonkey, said he had bought Call options of GameStop. “Lots of $GME (GameStop) talk soooooo… We bought Feb $115 Calls on $GME this morning. Let’s gooooooo!!!!!!!!” he announced on Twitter. Chamath’s tweet sent the stock soaring another 93 per cent on Tuesday.
BATTLE OF IDEAS
While it is easy to dismiss the entire episode as an epitome of dumb (retail) money taking impassioned bets in the stock market without any fundamental foundation, some members of the group feel otherwise.
“They’re scared of the future. They’re scared because, so much information is available for free now. There’s no more fees for trading. We have large communities that discuss stocks and trading openly. We can think and make decisions for ourselves, which scares old school institutions and hedge funds,” one anonymous Reddit user posted on the group.
For decades, equity investing has been treated as hallowed temple. Think about the Vedas that could only be read, understood and propagated by the Brahmins. However, the advent of zero-commission trading apps across the world and the democratisation of knowledge caused by the Internet have made a few question that wisdom.
Last week, Nimesh Shah, Managing Director and Chief Executive Officer of ICICI Prudential Asset Management Company, argued that social media had become a big risk in his investment decisions.
“I had to liquidate 50% of a credit risk fund in four days after that (Franklin) episode due to fear mongering on social media. Now, we have to be fully prepared and worry about this herd mentality risk and social media risk,” Shah told the audience at the ETMarkets Global Summit.
A KNEEDLE THAT POPS THE BUBBLE
For those with a ring-side view of this battle, the entire episode has raised alarm bells and led to deeper introspection about the current state of mind of the equity market, which has seen a gravity defying run since the Covid-19-led crash of March.
Helped by trillions of dollars of liquidity pumped in by global central banks and staggering fiscal stimulus by governments around the world, equities have seen a linear rise led by the new-age retail investors, wielding commission-free trading applications and advise from social media.
“The GameStop thing is a reminder that investing is not the study of finance. It’s the study of how people behave with money, and sometimes those behaviours are incredible,” Morgan Housel, author of Power of Money and partner at the Collaborative Fund, tweeted.
Back home, too, there have been examples of what some market participants termed reckless bets by retail investors. ETMarkets.com earlier this month reported how stocks in ‘Z’ group of NSE, known for their lack of compliance and shoddy corporate governance, had seen a burst in trading volumes and staggering price gains despite many of being earmarked for trading bans.
Many believe the GameStop episode may end up being a marker in the history of the current bull market in global equities, drawing parallels with other episodes of irrational exuberance seen in the bull markets of the past.
While no one as yet can be certain if this will bring about the downfall, one can lean on the words of Michael Lewis’, the author of The Big Short, to succinctly capture this unique moment in global financial history: “The line between gambling and investing is artificial and thin. The soundest investment has the defining trait of a bet, and the wildest speculation has the salient characteristic of an investment. Maybe the best definition of ‘investing’ is “gambling with the odds in your favour.”