GameStop's short squeeze: The Buying Behind the Surge
GameStop's January 2021 surge involved a short squeeze, a market event that brought large losses to investors betting against the video game retailer. Approximately 140 percent of its public float had been sold short. Reddit users on r/wallstreetbets initially and primarily triggered the event, although hedge funds also participated. At its height on January 28, the stock briefly exceeded $500 per share in pre-market trading, compared with $17.25 at the beginning of the month. The price of many other heavily shorted securities and cryptocurrencies also increased.
The company had faced pressure before the surge. GameStop's brick-and-mortar stores competed with digital distribution services, while the COVID-19 pandemic reduced in-person shopping. Its share price declined, and many institutional investors expected further falls. Other investors saw potential value. Michael Burry's Scion Asset Management acquired a stake in 2019 and urged the board to buy back shares. Ryan Cohen disclosed an investment in August 2020 and joined the board in January 2021. His arrival triggered a rally, with the move interpreted as favorable for the gaming retailer. These business developments formed part of the setting for the trading that followed.
The mechanics of a short squeeze begin with borrowed shares. A short seller borrows stock, sells it, and hopes to purchase it later at a lower price before returning it to the lender with interest. The intended gain comes from the difference between the selling and repurchase prices. A rising share price puts that position under pressure instead. Losses on this kind of position have no inherent ceiling because the stock price has no inherent upper limit. That differs from simply owning a share, where the investor's potential loss is limited to the amount initially invested.
When sellers buy shares to close those positions, their purchases create additional demand. That demand can push the stock higher, encouraging more sellers to buy back shares to contain their losses. In GameStop's case, the unusually large amount of stock sold short meant some shares had been lent again and shorted again. Participants discussing the company on r/wallstreetbets saw that concentration as an opportunity. They believed buying could lift the price until investors betting on a decline had to close their positions at substantial losses. The resulting pressure connected rising prices with further demand for the same stock.
Trading volumes and price movements grew rapidly. More than 175 million GameStop shares changed hands on January 25, compared with a recent average volume of 29.8 million shares. The price rose 1,500 percent over the weeks ending January 27, and volatility caused trading to be paused repeatedly.
Brokerage restrictions introduced another financial pressure. On January 28, Robinhood stopped customers from opening new positions in GameStop and other volatile stocks while still allowing positions to be closed. Other platforms also restricted buying. Several brokerages said clearing houses had raised the collateral required to execute trades. At the time, settlement involved a delay between a purchase and the exchange of cash and securities, so brokers posted collateral to guarantee completion. Clearing houses could request more collateral as volatility increased. The short squeeze was followed by anger over the restrictions, lawsuits against Robinhood, and a congressional hearing on the incident.
The gains also reversed sharply. GameStop's shares lost more than 80 percent of their value from the previous week's intraday peak during February 1 and 2. Some retail investors bought near peak prices or held shares through the decline, suffering significant losses. The stock later rebounded: on February 24, its price doubled during the final 90 minutes of trading. Reports could not identify a specific cause for that surge. In March, further price swings accompanied company developments, including plans for a committee to support its move toward e-commerce and an announcement about a potential secondary stock offering.
The financial results varied across professional investors as well. Melvin Capital, which had heavily bet against GameStop, lost 53 percent of its investments by the end of January. Citadel and Point72 invested additional money in the fund before it said it had closed its position. Senvest Management, which had bought GameStop shares before the short squeeze, made a profit of $700 million when it exited. Major asset managers could gain through their shareholdings or by lending stock to short sellers. Brokerages, trading systems, and market makers also benefited from the unusually high volume of transfers, giving the activity several distinct financial beneficiaries.
- Wikipedia, GameStop short squeeze — en.wikipedia.org