Gamestop Explained

Written by: Chao Fangning Nicole (20-U5)

Designed by: Poh En Xi (20-E3)

GameStop: A Brief Introduction

Earlier this year, an event which took over social media puzzled many of us. On social media platform Reddit, many users from the Reddit thread r/wallstreetbets began posting their investments in a retail gaming chain, Gamestop. Shockingly, their investments had skyrocketed in value seemingly overnight! However, in trying to understand the whole situation, you probably would have come across very confusing economic jargon such as “options” and “shorting”. Fear not! In this article, we’ll be breaking down the GameStop story for you, where just like the age-old story of David and Goliath, a ragtag gang of Reddit users managed to take away billions of dollars from the biggest wolves of Wall Street.

Who’s Involved?

GameStop is a brick-and-mortar gaming retailer that has been struggling to survive, since many gamers can now order their equipment online. Their dire situation was further exacerbated by the pandemic which confined people to their homes and unable to go out to the malls. 

r/wallstreetbets is a subreddit for young amateur retail traders and investors who are known for their aggressive trading strategies that ignore the most fundamental trading techniques and practices, often using slang such as “stonks” when referring to stocks. However, users on r/wallstreetbets are also known to coordinate together and drive up the share prices of companies that are struggling such as Blackberry, Macy’s, and most notably, GameStop. In short, they are a group of amateurs investing or buying shares in things they probably shouldn’t.

Robinhood is a trading platform that, unlike most platforms, does not require a fee for users to begin trading. Furthermore, it is popular for its many glitches that users exploited. Past examples include the “Infinite Leverage Glitch” which gave users access to what was essentially free money from borrowed funds to trade with. Most users from r/Wallstreetbets used this platform and shared about other glitches in its system on the subreddit.

Hedge funds are alternative investments with the goal of maximising returns and minimising risks that use unconventional trading strategies. Most of the time, these hedge funds are funded by the highest elite of Wall Street with overflowing cash. 

Short-sellers are investors who bet against a company’s share prices and profit when the price of the shares fall. The way this works can be a bit confusing, but here’s an analogy to hopefully help you better understand . Imagine a shop selling apples for $1. However, you predict that there will be a fall in the demand for apples in the future, and as the many of us taking Economics know, this would cause a fall in the price of apples. So, you decide to borrow an apple from the store right now and sell it to your friend for $1. However, you would eventually  have to return the apple to the store at some point right? Let’s assume your prediction was correct and the price of an apple has fallen to $0.80, allowing you to buy back an apple from your friend at $0.80 to return to the store. Overall, you would have made a profit of $0.20. This is, in short, how short-selling (also known as shorting) works!

Another important term you should know about is an option to call. An option to call is essentially a contract signed by a buyer who then has the right to buy an underlying asset at an exercise price (which is fixed) within a specified time period. The buyer may choose not to exercise his option and not buy the asset. For example, let’s say you have bought an option to call and have agreed to buy a pack of candies for a fixed exercise price of $1. If the value of that pack of candies is $0.90 today, you would probably not choose to exercise your option to call as $1 is more than $0.90, and you would rather buy the candies $0.90 than at the fixed price of $1. However, if the value of that same pack of candies is $1.10 tomorrow, you would probably choose to exercise your option to call tomorrow as $1 is less than $1.10, which means that you would be buying the pack of candies valued at $1.10 for a lower price of $1! 

Many millennials detest hedge funds and short-sellers, especially since they can be seen as the culprits causing the 2008 Financial Crisis, which, if you’re interested, a movie called “The Big Short” delves into. Moreover, hedge funds are known for manipulating what is supposed to be “the free market” in order to increase their profits, often at the expense of many workers’ livelihoods. 

Now that we have introduced the main players of this GameStop debacle, we will now explain how the whole event played out.

What Happened?

GameStop had been  struggling to stay afloat due to decreasing demand, with their shares falling from 16 USD in January 2019 to 5 USD one year later. This was good news for hedge funds and short-sellers who, upon seeing this, then began shorting more of GameStop’s shares than what had actually existed. 

You may be wondering how it is even possible to short more shares than what actually exists. Going back to the apple analogy, let’s say that the friend you’ve sold your apple to has lent their apple to another person who is also planning to sell it to someone else. Now, both you and your friend’s friend owe someone an apple. 

Users on r/wallstreetbets noticed this and figured that since these hedge funds and short-sellers were shorting Gamestop’s shares excessively, if the price of the shares went up instead, the seemingly undefeated and powerful hedge funds would not just lose some money, they would lose billions as they would have to buy more shares at a higher price to make up for the shares that they sold despite not having them. 

Thus, Reddit users began placing an option to call. As more and more people began buying stocks from GameStop, the demand for stocks was greater than the supply, causing share prices to rise sharply from 4 USD to 200 USD by January 2021. Thus, many people who had bought shares through their options to call were able to make huge amounts of profit.

As a result, hedge funds and other parties who bet against GameStop collectively lost more than $5 billion. On the other hand, many Reddit users shared how buying options on GameStop allowed them to pay for medical bills and student debt, with many others congratulating r/wallstreetbets on their monumental achievement of taking down some of the largest manipulators of the market. 

What does this Mean for the Future?

The GameStop event has proven the significance of social media in the financial market, and its ability to gather and spur collective action against the larger players who we once thought could easily manipulate and control the market.

However, many platforms have felt the need to control the situation. Somewhat ironically, Robinhood limited the trades in GameStop, angering many users, especially since the platform is tied to a Wall Street firm Citadel Securities which owned a hedge fund that was badly hit by the GameStop short squeeze. 

Despite this, Reddit users still seem to be on a short squeeze frenzy. After GameStop, many have begun shifting their focus to other companies such as American Multi-Cinema (AMC) and Blackberry in hopes of recreating the incredulous victory of David over Goliath once again.

Bibliography:

  1. Allison Morrow, CNN Business. (2021, January 28). Everything you need to know about how a Reddit group blew up GameStop’s stock. CNN. https://edition.cnn.com/2021/01/27/investing/gamestop-reddit-stock/index.html
  2. BBC News. (2021, February 19). Robinhood boss says GameStop episode “unacceptable.” https://www.bbc.com/news/business-56116545 
  3. Chapman, B. (2021, February 1). GameStop: Reddit users claim victory as $13bn hedge fund closes position, accepting huge losses. The Independent. https://www.independent.co.uk/news/business/gamestop-share-price-reddit-hedge-fund-melvin-capital-b1793543.html 
  4. Hedge Fund. (2021, January 24). Investopedia. https://www.investopedia.com/terms/h/hedgefund.asp 
  5. How a Reddit user roiled GameStop stock and the markets. (2021, January 30). The Straits Times. https://www.straitstimes.com/business/invest/how-a-reddit-user-roiled-gamestop-stock-and-the-markets
  6. Money. (2018, October 25). https://money.com. https://money.com/wall-street-bets/ 
  7. Sraders, A. (2019, November 28). What Is a Hedge Fund and How Do They Work? TheStreet. https://www.thestreet.com/personal-finance/what-is-a-hedge-fund-14662109  
  8. Short Selling. (2021, March 13). Investopedia. https://www.investopedia.com/terms/s/shortselling.asp 

What’s the difference between a Call and Put option? – CommSec. (2021, April 13). CommSec. https://www.commsec.com.au/support/frequently-asked-questions/1405.html#:%7E:text=A%20Call%20Option%20gives%20the,or%20within%20a%20specified%20time.

Posted by

With great power comes great responsibility.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s