GameStop
In early 2021 the shares of a video game chain rose many times over within a few weeks. Behind it were lots of short sellers, a crowd of private investors who exchanged ideas in forums, and forced buybacks.
GameStop was a chain of video game shops whose business was shrinking. An unusually large number of its shares had been sold short, borrowed and sold by people betting on falling prices. At times more shares were sold short than were freely traded at all.
In early 2021 many private investors began exchanging ideas in forums and buying the shares. The price rose, the short sellers made losses and had to buy back. Those buybacks drove the price higher still. In early January a share cost under 20 dollars, on 28 January it briefly topped 480 dollars.
That's a short squeeze, exactly as described in the lesson Short selling. The price rose many times over, although nothing had changed about the company's business.
The story is often told as a victory for small investors. For those who bought early, that's true. Anyone who got in late because they'd read about it in the news bought close to the peak. On February 19 the shares closed back at around 40 dollars. The two groups rarely appear together in the story.
The shares were so vulnerable because a very large number had been sold short relative to the freely tradable shares. When the price rises, short sellers have to post more collateral or buy back. Because their loss has no upper limit, many are forced to close, and that amplifies the move.
The options market amplified this. Many people bought calls on the shares. Those who had sold the calls hedged by buying the shares themselves. That brought even more buying. This feedback loop through options is seen as one of the main drivers of the rise.
The case also shows the limits of the story that now anyone can have a say on the stock market. The rise shifted money between market participants and had nothing to do with how much the company earns. It went equally badly for the late buyers and for some of the short sellers. What some won, others lost.
Summary
- A short squeeze comes from forced buybacks, not from the company doing better.
- Hedging purchases by option sellers amplify the move further.
- The story tells of the winners, not the late entrants.
Did you get it?
What makes a stock vulnerable to a short squeeze?
When a very large number of shares are sold short relative to the freely tradable shares.
How does the options market amplify the move?
Those who sold calls hedge by buying the shares themselves. That brings extra buying.
Why is the retail-victory narrative incomplete?
Because the late buyers got in close to the peak and lost a lot.
Your task
The price jumped from under $20 to over $480 for a short time, with no change in the business. How would you recognize that you are getting in too late? Calculate by how many percent the stock fell from $480 to about $40, and how much of $1,000 invested at the peak would have been left.
Sources and further reading
- US securities regulator's report on the market events of January 2021, plus public price and position data. View source ↗
Related
- Short sellingStage 5
- Hedging with optionsStage 5
- Not your keys, not your coinsStage 2