Meme Stocks; Is GameStop back?

Just when we thought the meme stock craze was put into the history books as a lock-down game played by a small army of retail traders taking on ‘the Man’ they roared back to life recently.

What is a meme stock? Meme stocks are shares that become popular on social media mainly by retail traders exchanging funny internet memes on platforms like Reddit/WallStreetBets and Twitter. Many meme stocks have underdog status on Wall Street as they have business models that are considered wonky or outdated by the financial establishment The trick of the meme stock game is to create traction for a stock and make money when others follow, the so-called pump and dump trade. Meme stocks tend to stay in the realm of retail traders, away from the ivory towers of Wall Street. But all of that changed with GameStop, now the most famous meme stock of all times, which in January 2021 brought meme stocks traders into an epic clash with Wall Street.

Why did GameStop become such a famous meme stock?

GameStop is a much-loved regional US chain of brick-and-mortar stores selling mainly videogames and consoles without (then) an apparent online presence and hence seen as obsolete by Wall Street. But how could a faltering business like GameStop become the object of such a frenzied and unprecedented rally of its share price, which doubled nearly every day in January 2021, from $17.69 on January 4th to a high of $483 on January 28th? This millionaire-maker price rise of its stock was possible due to a short-squeeze.

What is a short squeeze?

Short positions are opened when an investor/institution thinks a company has an overvalued share price and short sells its shares via option contracts. This kind of selling does not require the investor/institution to own the shares in that company now. And as the sellers are so sure the price of the shorted stock will be going down they think nobody will want to buy the shares at the agreed price at the agreed future date and the option will expire worthless. The short seller receives a premium for selling the option. But if the share price of the underlying company goes up instead of down, the buyer of the option may want to exercise their right and have the shares delivered at the pre-agreed contract price. This is a nightmare scenario for short sellers as they don’t have/own the shares and now need to buy them on the open market at a loss.

What set off the mother of all short squeezes (MOASS)

The GameStop short squeeze started because a hedge fund, Melvin Capital and a research firm, called Citron Research – a famous short seller -, both publicly announced in January 2021 that they had shorted GameStop. A large short position by any hedge fund on Wall Street can be like a death sentence for a company and its stock, because generally, the market believes and follows the investment actions of well-established Wall Street hedge funds, such as Melvin Capital. Existing shareholders in a company shorted by a hedge fund may be duly worried about losing money on their investments and may start selling their shares. The share price consequently starts to slide and the hedge fund manager who has opened the short position will be happy as this is exactly what was aimed for.

But in the case of GameStop, the WallStreetBets crowd (with time on their hands) took offense at the arrogance of the short traders and they put up a fight. This was personal. This was a battle of insiders versus outsiders, of big versus small and of Wall Street versus the rest of America. This army of dedicated retail investors (they called themselves the ‘Apes’) decided they wanted to ‘save’ GameStop from the nasty fund managers at Melvin Capital and Citron Research (the shorters) and they united on social media. The Apes went crazy and starting buying and hoarding GameStop shares, reversing the predicted share slide, urging all other GameStop holders to ‘HODLE’ (hold and hoard) and to have ‘DIAMOND HANDS’ (no selling, no wavering). And it worked. The GameStop share price kept rising, bringing ever more buyers into the market, creating an almost unstoppable upward movement of the share price.

Melvin Capital and Citron Research looked as if they had made the wrong bet, but they persisted, and the fight carried on with heavy losses for the shorters. Melvin Capital at one point in January 2021 was losing $1 billion a day on its short position in GameStop. The shorters eventually had to close out their positions as they were untenable. Melvin Capital lost $6.8 billion in total and had to be bailed out by another fund to avoid collapse. Its reputation badly dented.

The outsiders and underdogs won this time. Their fight took guts, coordination and faith. It took diamond hands indeed. Many of the GameStop holders also made life changing amounts of money on their GameStop shares, almost flowing directly out of Melvin Capital’s coffers. It is a 21st century Robin Hood story.

The meme stock army showed how we love the power of a good story; how we prefer optimism over cynicism and that underdogs can win too. It was a once-in-a-lifetime story. The fact that GameStop and other meme stocks are popping up again recently could, more than anything else, be just a whiff of nostalgia

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