Why a Reddit group pumped GameStop shares up 1,000% on a lark

Shares in a U.S. retail chain that hasn’t made any money in years have risen by 1,000 per cent in less than two weeks, wiping out billions of dollars from two Wall Street investment funds in the process.

The sentence above makes little sense at first blush, but it is nonetheless an apt description of the saga currently underway surrounding shares in GameStop.

GameStop is a retail chain with about 5,000 locations across North America which, as its name suggests, sells video games and game-related accessories.

Like many retailers, its business has been under pressure for several years now, because of a shift away from physical stores and toward online selling, which GameStop currently does very little of. Then the pandemic hit, exacerbated those problems and sent the stock down to multi-year lows.

In the early days of COVID-19, the company’s shares were changing hands at around $4 US a share. They hit almost $400 on Wednesday for no good reason other than being caught in the middle of an epic battle between a couple of million online Davids who share stock tips on profanity-riddled message boards and the bespoke-suited stuffy Goliaths of Wall Street investment funds.

Wall Street has been betting against GameStop shares for well over a year now as investors known as short sellers have profited from the company’s misery, driving the price down from around $25 in early 2017 to around $5 for most of last year.

Unlike long-term stock owners, short sellers make money on falling shares by borrowing the shares from existing shareholders, selling them and then buying them back to replace the shares they borrowed at a lower price later and pocketing the difference. 

As long as the price goes down, short sellers make money. But when the stock goes up, short sellers have to buy into a rising market, which adds to the buying pressure, which pushes prices up even more in a vicious cycle for the short. That’s known as a short squeeze, and what we’re seeing right now may be the most dramatic one in history.

Enter WallStreetBets

The short sellers’ best-laid plans for GameStop started to go off the rails a few months ago, when some members of a prominent Reddit community called WallStreetBets saw an opportunity to make some money and teach Wall Street a lesson in the process.

While many members of the subreddit of DIY investors genuinely think GameStop’s core business of selling video games is a promising one, a small number of them saw an added reason to buy in because they caught wind of a growing short interest in the stock.

If enough buyers buy into a company and refuse to sell, the theory goes, that will drive the price of the shares higher. That, in turn, forces short sellers to fuel the price rise against their will by making them buy at ever-higher prices to cover their bets. The harder it is to find a stock to cover the short, the more expensive it will get, until momentum shifts.

The member credited with starting the movement, who goes by the handle Deep[Expletive]Value has posted screen grabs that suggest he has managed to turn an initial investment of about $50,000 into more than $20 million, simply by buying and holding.

Holding the shares away from shorts also increases the cost of borrowing for shorts, who at one point this week were being charged one-third of the price of the stock for the right to short it. At current prices, that means it would cost about $100 to short the stock, which means any profit would depend on the stock price falling by at least that much. Which it isn’t doing.

Research firm S3 calculates that short sellers have lost $5 billion on GameStop so far this year.

The Redditor cited above declined an interview request with CBC News for this story, but he is far from the only one buying.

Alex Panayi is a regular contributor to the forum, and he says he saw a good investment case for the company months ago, based on their core business of selling video games. He took his first stake at around $30 and sold a bit at $55 but soon regretted it. Once he saw the momentum gathering, he added to his position again and again, even buying as high as $86 because, he said, the math added up. He could buy in relatively low into a business legitimately turning itself around, with the added bonus that he knew Wall Street had bet wrong and would have to buy in, too, to cover their bad bets.

“It’s not the retail investors being greedy, it’s … the short sellers,” he said in an interview. 

At one point, short interest in the stock topped 140 per cent. That means short sellers were trying to short more shares of GameStop than there are in existence.

“That’s greedy, and when that happens, they open themselves up for this huge risk,” Panayi said.

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