The TLDR: Here’s a Wall Street story that is 100% guaranteed to be turned into a Hollywood flick. It involves big hedge funds, the stock of a video game retailer and millions of Reddit users. And it’s got everyone worried—including the President of the United States. 

FYI: There’s a lot of insider jargon involved here. We promise to keep it simple not stupid.

The big picture 

GameStop’s stock was selling for $3.25 last April, but is now trading at $347.51—after hitting a high of $380 yesterday. For a moment, Gamestop had a market value of $26.5 billion—more than that of Delta Air Lines. Sounds like a Cinderella story, except this: the company—and problems with its business model—remains exactly the same. In other words, nothing’s happened in the real world to trigger this mad winning streak. 

More importantly: the same is going to happen to a number of other companies who aren’t doing well—and are not expected to, at least in the near future. For example: AMC theatres reeling from the pandemic or Blackberry… which, yes, is still in business. 

The big Qs: What does this do to the basic principles of how a stock market operates—and how shares are valued on it? Also: who—or more importantly, what— determines the value of any given stock? Those are the big questions at stake in this wild, wild story. And remember: The answers have a direct impact on your investments. For whither goes Wall Street...

Say hello to GameStop

• It is a brick-and-mortar chain of gaming stores in the United States—typically found in malls.
• And it hasn’t been doing well for a long time because, well, technology. Malls in the US are dying. People don’t go to stores to buy much of anything, including discs for video games. They just download them online. 
• The company already posted a loss of $470 million in 2019—and then the pandemic made everything much worse. 
• GameStop shut 300 locations, and the stock price was an abysmal $3.25 on April 1. 
• It was tail-spinning its way toward the corporate dustbin—until it got itself a new investor in August, Ryan Cohen. 
• The big man vowed to drag GameStop into the digital age, put in more money, and became part of the board in January. 
• Hope sprang eternal and the stock price jumped to a whopping $38.65. 

Enter, the short sellers 

Wall Street makes its money by predicting who will go up or down. And you can make as much by betting on who will lose as you would by picking a potential winner. Now, a lot of institutional investors (i.e. hedge funds) were betting against GameStop—figuring the new guy wouldn’t be able to save it. This is called ‘short selling’. 

How this works: This is how Wall Street types bet on a company’s future misfortune: 

• You ‘borrow’ a GameStop stock—for a certain fee—and sell it at the current market price, say $20 in December. 
• Then you wait for wizard Cohen to flail, and investors’ hopes to dim. 
• The stock goes down to say $5? You buy the stock back, return it to the person you borrowed it from, and pocket the difference. Simple.

Point to note: As Ars Technica notes, GameStop was a heavy favourite for short sellers:

“GameStop has been one of the most heavily shorted stocks on the market for a while now. Since the middle of 2019, the 'short interest' (i.e., the number of shares investors have expressed interest in borrowing for a short position) has heavily surpassed the stock's 'free float' (i.e., the number of actively traded shares available). In other words, investors as a whole were so sure that GameStop stock was going to go down that they wanted to borrow every single available share (and then some) to make money on the coming collapse. And keep in mind, this phenomenon started when GameStop stock was already trading at historic lows of $5 a share or less.”

As of Monday, 71.2 million shares of GameStop stock involved a short position.

Point to note: As with all kinds of gambling, short selling is an excellent way to make money if your guess is accurate. Let’s say you get it wrong—and the stock price soars instead. But you still have to return the stock you borrowed, remember? So you are forced to buy back that stock at a higher price than you paid, and lose a whole lot of money.

Cue the short squeeze 

r/WallStreetBets: The hedge funds would have likely made a pile of money on GameStop except for one intervening factor: A Reddit community called r/WallStreetBets which has around 2.9 million members as of now. Their slogan: "Like 4chan found a Bloomberg Terminal.” These are retail (individual) investors who loathe big Wall Street hedge funds. As Bloomberg News explains it:

“Online brokerage Robinhood Markets Inc. and other app-based platforms have brought a new wave of at-home traders into the market—many of them working from home or idled by the pandemic—raising concerns about the ‘gamification’ of investing. Those on r/wallstreetbets—the Reddit forum dedicated to ‘making money and being amused while doing it’—have set their sights on exploiting a financial system that’s perceived to have locked them out for years.”

The great squeeze: Now, the community has been talking up GameStop for over a year. But the turning point came when interest turned into outright aggression. In September, someone posted a seven-point treatise titled ‘Bankrupting Institutional Investors for Dummies, ft GameStop’. 

We won’t sweat the details, but the community essentially decided to take down big hedge funds who were heavily betting on Gamestop’s failure—specifically Melvin Capital. The first question asked by WSB when they uncovered Melvin: “Have you robbed your billionaire today?” 

How they did it: 

• They swarmed out and bought lots and lots of GameStop shares—think millions of small investors moving the market all at the same time. 
• The stock soared to $148 at closing time on Tuesday.
• Now, those short-sellers have to buy the stock back—because they have to return it at some point, remember? 
• So to cut their losses—or ‘cover their short’—they started to buy GameStop stock before it climbs even further. And that pushed the price even higher! 
• That, in sum, is the short squeeze. 

Tightening the noose: Just to make short sellers even more miserable, two other dynamics kicked into play:

One: Lots of the WSB folks instructed their dealers not to sell any GameStop stock to short sellers—this put a squeeze on the shares available for trade. And that… pushed the price even higher.

Two: Most of these Redditors don’t buy their shares outright. Instead they use something called ‘call options’. 

• Let’s say you have $100 in hand and can buy one share of a company. 
• Or you can put a call option in on 10 shares. You put in less money per share—say $10—to reserve the right to buy 10 shares at a certain date. 
• If the price of those 10 shares goes up to $120 at the end of that period, then you make $20 per share. If it goes down, you lose the $100 you put in. 
• Now, here’s the rub: Your dealer is also buying that stock to cover herself—just in case she has to shell out money to you. That way, if the price goes up, she pays you and she makes money on the stock too. 
• So if lots of people have a whole load of call options on GameStop stock, then their dealers are also buying GameStop to cover their ass… which again drives up the price.

The bleed: Melvin lost so much money that it cut its losses, i.e. got rid of its shorts, and exited GameStop. And it needed a $2.75 billion bailout from outside investors to stay in business. One of its saviours is another hedge fund Point72 which lost 15% just this year, pointing to a potential ripple effect.

Point to note: GameStop has now set a precedent—and given the subredditors a taste of blood. And their success is spreading to other platforms including TikTok, Discord, Facebook and Twitter. In recent weeks, they’ve turned their attention to other favourites of short sellers. These include the theatre chain AMC, Blackberry, Data-analytics firm Palantir Technologies and home retail chain Bed, Bath & Beyond. This is just the beginning…

The bottomline: The GameStop saga shows how internet platforms can unite individual investors and help them move markets and make crazy money—a power once reserved for the heavy hitters. It is also playing out as a generational battle: middle-aged Wall Street honchos punked by Gen Z/Millennial subredditors. Or as one of them put it: “Please tell the wolf of Wall Street that the pigeon of San Francisco is gonna eat your lunch.”

The other way to look at it: This spells total chaos for not just Wall Street but also —thanks to a domino effect—for global markets, which are at the mercy of the ‘sentiments’ of a large crowd of investors. James Surowiecki calls this a “meme stock bubble”—where these campaigns are played out for short term gain, be it profit or just fun:

“The challenge, of course, is that once that collective will begins to erode—either because people want to cash out or just get bored—there are going to be no fundamentals supporting the stock price, which means once these stocks start falling, it’ll be look out below. But by the time that happens, much of the crowd will have moved on. There are always going to be crappy, heavily shorted stocks out there—which means there’s always going to be a chance for more lolz.”

Reading list

Vox has the most detailed explainers. Ars Technica also looks at whether the GameStop game is legal. Brandon Kochkodin’s rundown in Bloomberg News lays out the chain of events most clearly. Also in Bloomberg News: On-point answers for the big questions it raises about Wall Street’s future. James Surowiecki politely raises the alarm in Marker. Wall Street Journal via Mint lists the next targets for Reddit bull raiders.  Hollywood Reporter focuses on AMC, and what it means for the entertainment industry.

More recommendations via subscriber Pranav Kiran: A New York Times profile of Wall Street’s most famous short sellers, Andrew Left (who was hounded into silence by WSB). An older Reuters story that reminds us of another renegade band of investors—but they were short sellers. This podcast episode features Jim Chanos—who famously shorted Enron.