GameStop and The Supposed Short Squeeze

In the wake of the recent Gamestop stock commotion, many have wondered what caused it in the first place and whether or not it was legal. To set up the answer to those questions, first, take a look at the response of Sen. Elizabeth Warren regarding the topic:

"The GameStop roller coaster shows what can happen when the stock market is played like a casino and the SEC can't or won't stop market manipulation," she tweeted afterward. "If we want a healthy stock market, we need a cop on the beat to do their jobs."

Responses like this to the GameStop stock push aren't uncommon to see on the news; however, was it really the case that a bunch of people on Reddit took part in market manipulation? Personally, I argue that what Sen. Warren said was false and that the GameStop conundrum was more of a slap on the wrist to hedge funds than anything. Everything starts with a hedge fund called Melvin Capital and their decision to start short selling GameStop Stocks.

First, Short selling stocks is a more uncommon form of participating in the stock market that involves borrowing other people's stocks. To explain, if one wanted to short a stock, they would first have to find a broker to lend them the stock that they believe will fall in value for a certain period of time. Once the stock has been received, that person will sell it at the market price and then wait for the given period of time to end before they have to buy back the same stock and return it to the broker. If the individual was correct and the stock's value dropped, they will have made a profit since they bought back the stock for cheaper than they sold. However, the GameStop case is where we see the opposite happen.

With Gamestop, as I explained above, hedge funds felt that its stock value would drop significantly and decided to buy up as many short contracts as they could on Gamestop. Under normal circumstances, these hedge funds would have likely made money off their gamble, but a small Reddit group called r/wallstreetbets picked up on their scheme ahead of time. Having noticed that GameStop was being shorted on a considerable scale by large hedge funds, these Reddit users decided to collectively buy up as much GameStop Stock as they could in response. This move spurred other individuals into also buying into GameStop, causing its stock value to increase. Although hedge funds would only lose a little money if the stock only grew a few dollars, things get crazier than anyone at Wall Street could have imagined.

To elaborate, the result of Reddit's Gamestop stock push didn't cause the stock to increase in value by a few dollars, but by as much as a hundred dollars from January 21st to January 25th. This initial jump was extremely significant because it helped propel the GameStop stock from reaching 140$ all the way up to 400$ or more. While one might question why this would be the case, since it would make more sense for everyone to sell on the rise and take their profit, it's actually pretty straightforward. Basically, once these hedge funds saw the price of GameStop shoot up, they began to believe that it was more likely for GameStop to keep growing than it was for them to make money off their short deals eventually. As a result, all these hedge funds were forced to buy GameStop shares to minimize their losses making its stock value go through the roof. This caused people to hold their stocks for value, creating the situation that we ended up in where hedge funds were forced to spend billions just to cut their losses.

Although more drama lurks with multiple lawsuits being aimed at the large stock-buying app Robinhood, a potential topic for future blog posts, we'll conclude by discussing the legality of everything that went down. In short, it's reasonably clear that these investors on r/wallstreetbets did nothing wrong. While groups like Melvin Capital and Citadel may be aiming to get some help from congress, it really doesn't feel like they have any claim to make. Thinking about it on the simplest level, r/wallstreetbets is a group that got together to bet on a stock, and melvin capital was a group that was essentially doing the same by engaging in short selling. The only difference was that the one that usually wins got the short end of the stick for once. Regardless, it's important to keep an eye on situations like these to maintain the integrity of the market and learn how to better immerse ourselves in it.