GameStop short squeeze


In January 2021, a short squeeze of the stock of the American video game retailer GameStop and other securities took place, causing major financial consequences for certain hedge funds and large losses for short sellers. Approximately 140 percent of GameStop's public float had been sold short, and the rush to buy shares to cover those positions as the price rose caused it to rise even further. The short squeeze was initially and primarily triggered by users of the subreddit r/wallstreetbets, an Internet forum on the social news website Reddit, although a number of hedge funds also participated. At its height, on January 28, the short squeeze caused the retailer's stock price to reach a pre-market value of over US$500 per share, nearly 30 times the $17.25 valuation at the beginning of the month. The price of many other heavily shorted securities and cryptocurrencies also increased.
On January 28, some brokerages, particularly app-based brokerage services such as Robinhood, halted the buying of GameStop and other securities, citing the next day their inability to post sufficient collateral at clearing houses to execute their clients' orders. This decision attracted criticism and accusations of market manipulation from prominent politicians and businesspeople from across the political spectrum. Dozens of class action lawsuits have been filed against Robinhood in U.S. courts, and the U.S. House Committee on Financial Services held a congressional hearing on the incident.
The unusually high price and volatility continued after the peak in late January. On February 24, the GameStop stock price doubled within a 90-minute period, and then averaged approximately $200 per share for another month. On March 24, the GameStop stock price fell 34 percent to $120.34 per share after earnings were released and the company announced plans for issuing a new secondary stock offering. On March 25, the stock recovered dramatically, rising by 53 percent.

Background

Short selling and short squeezes

is a finance practice in which an investor, known as the short-seller, borrows shares and immediately sells them, in the hope that they will be able to buy them back later at a lower price, return the borrowed shares to the lender, and profit off the difference. The practice carries an unlimited risk of losses, because there is no inherent limit to how high a stock's price can rise should the short-seller be proven wrong in their belief that the stock price was going to fall. This is in contrast with taking a long position, where the investor's loss is limited to the cost of their initial investment.
Short sellers are exposed to a risk of short squeezing, which occurs when the shorted stock jumps in value because, for instance, there is a sudden piece of favorable news. Short sellers are then forced to buy back the stock they had initially sold, in an effort to keep their losses from mounting. The market demand they create by purchasing the stock to cover their short positions further raises the price of the shorted stock, thus triggering more short sellers to cover their positions by buying the stock. This can result in a cascade of stock purchases and an even bigger jump of the share price.

GameStop

, an American chain of brick-and-mortar video game stores, had struggled in the years leading up to the short squeeze due to competition from digital distribution services, as well as the economic effects of the COVID-19 pandemic, which reduced the number of people who shopped in-person. As a result, GameStop's stock price declined, leading many institutional investors to believe it would continue falling, thus short-selling the stock. On January 22, 2021, approximately 140 percent of GameStop's public float had been sold short, meaning some shorted shares had been re-lent and shorted again. Analysts at Goldman Sachs later noted that short interest exceeding 100 percent of a company's public float had only occurred 15 times in the prior 10 years.
However, in mid-2019, investor Michael Burry's Scion Asset Management acquired a 3.3-percent stake in GameStop and wrote to the company's board of directors, identifying overlooked value in the company and urging them to buy back shares. In August 2020, Ryan Cohen revealed a 9-percent investment in GameStop, leading some to believe that the stock was undervalued. In January 2021, Cohen joined GameStop's board, triggering a stock rally.

Online discussion

The subreddit r/wallstreetbets is an online community on Reddit, a social news website. The community is known for discussion about meme stocks and high-risk stock transactions. Observers congregating around r/wallstreetbets believed the company was being significantly undervalued, and with such a large amount of the stock being short they could trigger a short squeeze, by driving up the price to the point where short sellers had to capitulate and cover their positions at large losses.
Even before the short squeeze, there had been interest in GameStop. Keith Gill, known by the Reddit username "DeepFuckingValue" and by the YouTube and Twitter alias "Roaring Kitty", purchased around $53,000 in call options on GameStop's stock in 2019 and saw his position rise to a value of $48 million by January 27, 2021. Gill, a 34-year-old marketing professional and Chartered Financial Analyst from Massachusetts, stated that he began investing in GameStop during the summer of 2019, after believing the stock to be undervalued. He shared information regarding his investment on r/wallstreetbets, providing regular updates on the investment's performance, including times when the investment had plunged. He stated on January 29, 2021, after the GameStop short squeeze, that he "thought this trade would be successful" but "never expected what happened over the last week", adding that he planned to continue his YouTube channel as Roaring Kitty and potentially buy a house.
Another user, Stonksflyingup, posted a humorous video on October 27, 2020, explaining how a short position by Melvin Capital could be used to execute a short squeeze, using a scene from Chernobyl to illustrate how the hedge fund would blow up similarly to a nuclear reactor.
On January 27, 2021, technology news website Mashable reported that the r/wallstreetbets subreddit had received 73 million page views in 24 hours –– breaking all-time traffic records. On January 29, the community surged by 1.5 million users overnight –– to a total of 6 million users –– making it the fastest-growing subreddit at the time. Reddit moderators temporarily closed the subreddit to the public, and Discord moderators temporarily banned the server for "hateful and discriminatory content."

Rise in stock price and volume

In January 2021, Reddit users on the r/wallstreetbets subreddit built the foundations for a short squeeze on GameStop, pushing up the stock price significantly. This occurred shortly after a comment from Citron Research predicting the value of the stock would decrease. On January 11, the stock jumped following the announcement that activist investor and Chewy co-founder and former CEO Ryan Cohen was joining GameStop’s board, a move that was interpreted as positive for the gaming retailer. The stock price increased 1,500 percent by January 27 over the course of two weeks, and its high volatility caused trading to be halted multiple times. According to Dow Jones market data, more than 175 million shares of GameStop were traded on January 25, the second largest total in a single day, surpassing its 30-day average volume of 29.8 million shares. Some of those investing into the stock were young teenage investors.
Later analysis by a cyber security company of social media posts suggested that thousands of automated bots may have hyped GameStop stock, Dogecoin, and other stocks, on social media. However, it is unclear the extent to which the suspected bot accounts influenced trading.
After GameStop's stock closed up 92.7 percent on January 26, business magnate Elon Musk tweeted "Gamestonk!!"—a reference to the "stonks" meme rising in popularity at the time—along with a link to the r/wallstreetbets subreddit. A brief, sharp rise in the share price to over $200 followed Musk's tweet., the all-time highest intraday stock price for GameStop was $483.00. In pre-market trading hours the same day, it briefly hit over $500, up from $17.25 at the start of the month.
The r/wallstreetbets Discord server was banned on January 27 for violating the company's restrictions on hate speech. However, users quickly formed similar servers on the application, and Discord reversed its decision the next day, attempting to help the community moderate its server instead.
On January 27, r/wallstreetbets triggered a short squeeze on AMC Theatres, a company in a similar position to GameStop. The value of AMC Networks also increased significantly, which was believed to have happened because of the stock's name being similar to AMC's. Disruptions and restrictions limiting trade have been reported on multiple brokerages such as Charles Schwab Corporation, its subsidiary TD Ameritrade, and Robinhood. According to Bloomberg, U.S. trading volumes on January 27 exceeded the peak set in October 2008 during the 2008 financial crisis, and was the third-highest in dollar terms within the last 13 years on record.
On January 28, more than 1 million GameStop shares, then worth $359 million, were deemed failed-to-deliver. On that day, GameStop's total market cap reached $33.7 billion which made it temporarily the highest valued company on the Russell 2000 index.
According to the Financial Times, a "gamma squeeze" also took place in addition to the short squeeze: as traders bet on the rise of stocks by purchasing call options, options sellers hedge their positions by purchasing the underlying stocks, thereby driving their prices even higher.

Halting of stock purchases

On January 28, Robinhood halted purchases of GameStop, AMC Theatres, BlackBerry Limited, Nokia Corporation, and other volatile stocks from its trading platform; customers could no longer open new positions in the stock, although they could still close them. Other brokerages soon followed suit. Many traders were furious, and called for class-action lawsuits in multiple popular Reddit posts. After the markets closed, Robinhood announced it would begin to allow "limited buys" of the affected securities starting the following day, although it was unclear what "limited buys" entailed. Trading platforms such as UK-based Trading212 and Israel-based eToro blocked buys of GameStop and other stock while continuing to allow sales. Webull halted buy orders for stocks affected by the squeeze, but soon thereafter allowed orders to continue. Anthony Denier, the CEO of Webull, stated that increased collateral requirements for their clearing house meant Webull themselves were restricted from opening new positions. Some users alleged that Robinhood was selling shares without consent; Robinhood denied these allegations.
Several brokerage firms, including Robinhood, stated on January 29 that the restrictions were the result of clearing houses raising the required collateral for executing trades. Because there is a lag between the moment when investors purchase a security and the moment cash and securities are actually exchanged, brokerage firms have to post collateral at clearing houses to guarantee the proper settlement of their clients' orders. Clearing houses include the Depository Trust & Clearing Corporation for equities and the Options Clearing Corporation for options. Clearing houses must have enough collateral on hand to settle a member's outstanding transactions in the event any particular member firm fails—to prevent cascading failures of other members—and can demand additional collateral from members if market volatility starts to increase. Brokerage firms claimed that the increased collateral could not be provided in time, and, as a result, trading had to be halted. The DTCC, for instance, increased the total industrywide collateral requirements from $26 billion to $33.5 billion, noting that the large trading volumes in specific stocks "generated substantial risk exposures at firms that clear these trades  particularly if the clearing member or its clients are predominantly on one side of the market". On January 29, it was reported that Robinhood had raised an additional $1 billion to protect the company from the financial pressure placed by the increased interest in particular stocks and meet the collateral requirements of clearing houses.
As of January 29, Robinhood was still imposing limits on the trading of GameStop, AMC, and Blackberry stocks. On January 30, Robinhood announced it had added purchase restrictions to 50 securities, including companies such as Rolls-Royce Holdings and Starbucks Corporation. However, on January 31, Robinhood announced it had removed several of these restrictions and would only limit purchases of eight securities.