Recently, the words Reddit, r/WallStreetBets, GME and “stonks” have been in the limelight for quite some time, and have ultimately risen as the bane of two major hedge funds on Wall Street, and it is they who are responsible for making the hedge funds go “sToNkS?”
So, let’s retrace the story which shares the likeness of a modern day RobinHood plot, but with the twist that it was the poor who politely socked the rich right in their jaws by doing the very same thing that they have been earlier pulling on them for years.
GameStop, or GME is a retail chain of stores primarily dealing in electronic gaming consoles likes the PlayStation and Xbox Series, along with their merchandise and games. Over the past year, their revenue stream was severely impacted by the announcement of worldwide lockdowns because of which majority sales of games were going through online modes of purchases. GameStop lost about $5 billion in revenue, which forced them to shut down the majority of their chain of retail stores.
Given the bad condition of GameStop and their stock which was trading at $17.25 at the beginning of the year, and at around $4 a week before. This low price of its shares prompted an organisation called a hedge fund over at Wall Street to “short” the stock, with the hedge fund in question here is Melvin Capital.
So, the people over at Melvin Capital thought they could gain a lot of money by “shorting” GameStop’s stock. So, what essentially is “shorting”? I’ll try and explain the best I can.
Shorting typically is a process of profiting off against someone else’s loss. Let’s say person A wants to profit off a stock who’s price he thinks is going to decline, but he doesn’t own any share of the company in particular himself (we shall assume the company is named XYZ Ltd). So what A does is that he “borrows” a few shares of stock from his broker, with a promise to deliver him back the same amount of shares after a while.
A then goes ahead and sells off those shares, and then waits for the stock price to fall. When the share price of XYZ Ltd does indeed fall, A goes ahead and buys the same number of shares that he sold, which he returns to his broker and hence earns a profit. The profit for A is the difference between the price at which he initially sold his borrowed shares and the lower price at which he purchased shares himself to compensate for the borrowed shares that he sold.
This is what Melvin Capital was trying to do. It borrowed a huge number of shares by paying brokers a shitload of money, with the aim of dumping that stock when the price fell even further and then buying back the shares that it had sold with a minuscule amount of money and returning it back to the brokers from whom the shares were borrowed.
However, this caught attention of a community of day traders on Reddit, who were part of a forum called r/WallStreetBets. Whenever a hedge fund is about to short a low-lying share, it has to make the information public, and based upon this particular information the people over at r/WallStreetBets decided to kick Melvin Capital’s greedy ass.
The people part of that forum started buying GameStop stock in bulk, thereby driving up the price of that share through the roof and began encouraging others to do the same. Since the value of the stock started going up immensely, more and more people jumped onboard and drew the price of that stock through the goddamned stratosphere.
This was a serious issue for the people over at Melvin Capital. Since they were responsible to transfer back the shares that they had borrowed, it meant that they would have to buy the shares at that particular price at which they were currently being traded. And since their purchase price was way more than the price at which Melvin Capital had borrowed those shares, it simply meant that Melvin Capital was screwed.
The share price of GameStop which was earlier trading at $17.25 blew up to ginormous proportions, and started selling it $145. This forced Melvin Capital to purchase the shares at the price of $145, which caused the stock price to go up even further, prompting it to reach the all time high of an absurd amount of $325. Overall, the stock price increased by 800% over this past week, which means that Melvin Capital is in a shit load of trouble.
This phenomenon is referred to as the Short Squeeze. This refers to the process of the rise in the value of a stock, which is prompted by traders who had earlier bet on the price of that stock falling, to purchase new stocks in order to forestall even greater losses, which only drives up the price of the stock even higher.
In simple language, Melvin Capital was forced to buy new shares at extremely high prices when they were the ones who had bet on the stock price to fall, so as to deliver the shares they had borrowed from others. This process of buying shares causes the stock price to go even higher, with each trade causing the losses faced by Melvin Capital to get bigger.
After all the dust caused by the mad stampede of trading GME stock settled momentarily, it was ascertained that Melvin Capital, a $13 billion hedge fund, faced losses up to more than $6 billion, which is literally almost 50% of its entire value.
The people over at r/WallStreetBets are highly determined to make this hedge fund pay, and have continued to hold onto their stocks so as to provide no scope for Melvin Capital to pay back its dues, which is essentially cutting their legs out of underneath them itself.
The chaos caused by GME stock was so much, that Robinhood, an app that deals in the purchase of shares and securities, just like India’s Zerodha, cancelled the option of trading GME stocks on its platform, which caused extreme uproar within the public domain. Robinhood also cancelled trading on two other stocks, namely AMC and Koss Corporation.
This doesn’t stop here too. The chaos surrounding this entire event was so much that the Securities and Exchange Commission started “closely monitoring” the trading of GME shares in the market. And for all those of you who have watched the Big Short or know how the SEC operates, means that the matter has officially started to go out of hand.
So, what happens now? What happens now is that Melvin Capital was so badly screwed that it was forced to be bailed out by two other hedge funds, Point72 and Citadel raised bout $2.8 billion to get Melvin Capital out from under. A $2.8 billion investment is roughly about 21% of the company’s original position of $13 billion.
So, for once it looks like the crony capitalists of Wall Street have been brought down to their knees by just a subreddit on Reddit which finally decide that enough is enough and decided to give them a taste of their own medicine. And the fact that Elon Musk, literally the richest man on Earth, is backing the people by simply tweeting #GameStonks on Twitter does indeed help them out to a considerable extent.
In the end, it looks like the capitalists got beat at the very game that which they designed, and the average day trader Joe is flush with cash and can use it to finally pay off his dangling mortgage/student loan that he was forced to burden himself with just because these banks and hedge funds created the norm in the first place.