Aakash W
If you have a decent internet connection, it is impossible to not have heard of what’s going on with Gamestop, a US based brick and mortar video game retailer. The news about its skyrocketing share price had been all over social media, taking the form of everything from analyst warnings to memes.
But what exactly happened? What were the factors that led to a penny stock essentially multiplying hundredfold? And what can be said about this in the backdrop of rising populist sentiment worldover?
It all started almost a year ago, when a Reddit handle by the name of u/DFV posted a position of theirs on r/Wallstreetbets, a subreddit dedicated mainly to risky options trades, memes and jokes about their wives’ boyfriends. Combining the absolute anarchy of 4chan and the absolute chaos of leveraged derivative trades, r/WSB is not the place one would expect to find well reasoned investment philosophy.
u/DFV first started posting about Gamestop back in 2019, prior to the start of the pandemic. He shared a screenshot, a long position worth 50 thousand dollars in call options in Gamestop, much to the ridicule of other users. A call option, by the way, is a contract that gives the holder the option (hence the name) to buy a stock at a given price, by a given date. The seller of the call option is obligated to deliver those shares. As the stock increases or decreases in value, so does the option, sometimes explosively so.
While the stock did not move much initially, it then started to get the attention of other forum members, especially when Ryan Cohen, an activist investor, took a 12% stake in the company. This bit of positive news boosted sentiment, and the stock’s price started to rise.
It was at this point forum members noticed something else, a huge outstanding short interest in the stock, almost a 150% percent.
Now, what is shorting anyway? Shorting, very simply put, is profiting by the decline in value of security. In this case, institutional investors, namely hedge funds, had borrowed shares and sold them, hoping to buy them back and return them when the price falls down. Shorting is expensive, as the person shorting often has to post large collaterals and pay interest etc. However, in the event the stock does the opposite, and instead rises in value, the person shorting the stock has to buy it back to cut their losses.
Noticing the huge short interest in the stock, r/WSB forum members realised that by buying the stock in a large coordinated effort, and holding it, would cause the stock price to rise sufficiently to inflict losses on hedge funds who had shorted it.
So, why would a bunch of retail traders want to do that? A deeper look at the sub-Reddit and its posts tells a very different story. Much like the rest of Reddit, the demographic of the sub is mainly Millennials, people who came of age during the Financial crisis of 2008, for whom the talk of debt, mortgage and joblessness would have been common. A lot of these people had immediate family members either laid off, or had their life savings ruined in the financial turmoil of the late 2000s. This occurred without any large banks or financial institutions taking any sort of responsibility, despite the fact that it was well established that faulty risk management practices and reckless lending by banks were the main driving force behind it and the recession that followed.
This sense of having been wronged is prominent throughout the subredddit, and manifests in posts that detail either what people went through during the financial crisis, or the way the institutions responsible were let off the hook so easily. What started as a meme slowly turned into a movement against the financial elites. This was like Occupy Wallstreet, except the battlegrounds were the financial markets.
Upon noticing the huge amount of short interest due to hedge funds, r/WSB realised that if they bought the stock continuously, the rise in price would force these hedge funds to exit their position by buying back the stop, effectively causing a further increase in prices. This, known as a short squeeze, is tremendously unprofitable for the entity shorting the stock, who effectively gets squeezed out of their position, while taking large losses.
A second phenomenon, known as a gamma squeeze, where people selling call options, such as banks, are forced to buy the stock to hedge their position also occurred, further propelling the stock price to new heights. The combination of these two mean that large financial institutions were forced to take huge losses, with one hedge fund, Melvin Capital, losing 30% of its Net Asset Value in less than a week.
However, it is hard to characterise the members of the subreddit as villains, despite mainstream media’s attempt to do so. Several posts showed how members used their profits to pay college debt, fix their houses, or in one particularly heart-wrenching post, pay for their dog’s surgery.
So, is financial populism here to stay? Personally, the rise of populist movements world over, rooted in race and ethnicity, is something I’m wary of. But the key difference here is that this wasn’t political. A quick glance through the forum makes one thing very clear, members of r/WSB are of all sorts of political orientations, from die-hard AOC fans to loyal Trumpists. What this was, was the intelligent gaming of a flawed system that for centuries has benefited the wealthy and well-connected. Retail investors have for long been the sacrificial lambs in the stock market, from having their orders front-run by algorithms, to being the last to receive any important corporate news. However, a collective anonymous effort, led by an edgy meme subreddit seems to have changed that.
One thing is certain. As retail investors become more savvy, the balance of power, and correspondingly, wealth itself, will shift.
Aakash Wilfred is a third year Metallurgical Engineering student and a part of the Credit SIG at ISTE . He likes quizzing, games of chance and is quite the fan of edgy Roald Dahl stories!
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