By: Shaan Bharwani
Self-proclaimed “Reddit degenerates” have incited a stock market war with the suits on Wall Street and brokerages are being forced to take sides. Notable companies caught in the middle include GameStop ($GME), AMC ($AMC), and Bed Bath and Beyond ($BBBY). How did this happen and what does it even mean?
Shorting Stocks
This entire fiasco stems from an investing strategy called “shorting”. Essentially betting that a stock price decreases, shorting is when a trader sells a borrowed stock with the intention of repurchasing it or covering it later at a lower price. For example, I firmly believe that Company X will decrease from $5 a share to $3 a share within the next few weeks. To capitalize on this, I use my brokerage (any trading platform like Robinhood, TD Ameritrade, WeBull, etc.) to borrow 20 shares of Company X and sell them at $5 each for a total of $100. It turns out I was correct, and the stock price becomes $3 a week later. As those shares that I sold weren’t mine, I now have to buy back and return the 20 shares I sold, but at the new discount price of $3 for a total of $60. Once those shares are returned, I walk away with a profit of $40. This sounds all well and good, but many shorts can go in the exact opposite direction. In my example, instead of the stock price falling below $5, Company X releases a cutting edge product, and suddenly their stock skyrockets to $20 per share. Now, I’m in trouble because the $100 worth of stocks I sold still weren’t mine. Instead of closing out a profit, I now have to buy back those 20 shares at a 4x rate of $20 each or $400. This time, I walked away with -$300. This is exactly what happened to several hedge funds that were shorting GameStop when Reddit decided they wanted to keep the company around.
GameStop
A brick-and-mortar videogame retailer visible in essentially every major mall for the last few decades was in danger of permanently shutting down due to the transition to online console retailers in recent years. Several hedge funds took notice at the beginning of the pandemic and decided that maybe they should help speed up the process. The biggest short position was taken by Melvin Capital, a hedge fund currently struggling to keep its doors open. Short positions are public records, so anyone at any point can Google what percentage of a company is being shorted, or bet against. Over 120% of GameStop’s shares were being shorted. That is more shares than GameStop has trading. This is an extremely rare case occurring because there were so many short positions that the same shares were being borrowed to sell multiple times. For a real world example, it requires four investors (A, B, C and D) who are all looking at Company X from earlier. A owns a share of Company X while B wants to short the company and does it using A’s share. C buys that share because he believes in the company. He has no idea it was a shorted share as there’s no way to differentiate. D, another person who wants to short the company, uses C’s share to do it. That ONE share has now been shorted 2 times and this transaction was so widespread that GameStop’s short interest topped 120%.
A subreddit, the name of a community on Reddit, called r/WallstreetBets took notice of this massive position against the classic retailer and collectively decided that they believe in the company’s future. Millions of everyday people started dumping their portfolios into GameStop and the stock increased from the high teens at the beginning of January to $468.49 on January 28th. This obliterated the short positions against GameStop as they suffered losses in the billions and Melvin Capital lost “53% of its $12.5 billion portfolio”, needing a $2.75 billion stimulus from the hedge fund’s allies to remain afloat (Wall Street Journal, 2021). This devastating communal move by the subreddit has raised eyebrows about whether it falls under an act of market manipulation.
Market Manipulation
A federal crime in the United States, market manipulation is the deliberate inflation or deflation of a security price or otherwise influencing the market for personal gain. Reddit users are being crucified by mainstream media and labeled as criminals for being individuals pushing the stock price up (The Hill, 2021). On the other hand, there isn’t a word about hedge funds buying up more shares than actually exist and then forcing the price down to ensure shorting profits. To add to the hypocrisy, Robinhood, a brokerage meant for the everyday person, removed GameStop from the platform at the urge of certain hedge funds who couldn’t handle the losses. Other brokerages such as WeBull and TD Ameritrade restricted the stock and, for a short time, would only allow people who already had positions to sell but no new shares could be bought. Several class-action lawsuits have been filed on Robinhood as the brokerage’s “actions were done purposefully and knowingly to manipulate the market for the benefit of people and financial institutions who were not Robinhood’s customers’’. While accusing retail investors of market manipulation, the company may have signed its own arrest warrant on the same charges.
Mini GameStops (Meme Stocks)
Fundamental analysis into a company is not an idea taken into consideration when it comes to this recent unprecedented stock market event. The consensus on Reddit is “if it’s being shorted, we take it to the moon”. AMC has been the runner-up of the pack, increasing 839% compared to GameStop’s 1745%. Bed Bath and Beyond, up 198%, is the last of the frontrunners who have been dubbed “Meme Stocks” by CBS. These companies have been struggling for separate reasons: GameStop becoming outclassed by online retailers, no new movies coming to AMC due to Covid-19, and Bed Bath and Beyond having to compete with more diverse companies like Target (CBS, 2021). The one thing they have in common, though, is they were all being heavily shorted by suits on Wall Street, which was enough for Reddit to propel them upward.
This once-in-a-lifetime event has left millions of investors with questions. Are the Reddit users guilty of market manipulation? Are the hedge funds? What about the brokerages? Others are questioning the ethicality of shorting stocks and profiting off the failure of companies. Regardless of what side one takes, the fact is there will be big changes or at least trials soon to decide what happens next.