You may never have heard of GameStop before, but it became one of the hot topics because its actions soared more than 2,000% this year thanks to a coordinated action by users of Reddit in the WallStreetBets community using brokerage apps like Robinhood. It is a very curious intersection between the financial market and technology for consumers that gives us the opportunity to learn concepts such as “option”, “short selling” and “short squeeze”. Understand below everything that has happened so far.
OK, open game: I don’t know exactly what stocks are.
Okay, basically, stocks are small pieces of a company. Some companies decide to sell part of their shares as a way to raise money, which is quite common: Microsoft, Apple, Google, Amazon, Facebook and Uber have been trading for years (or decades, in some cases).
These shares can be bought and sold on a stock exchange. They assume prices that, in the long run, tend to reflect their financial situation: for example, with successive profits, Apple today is worth more than $ 2 trillion.
And what is GameStop?
GameStop is a well-known retailer in the USA, where its stores sell consoles such as the PlayStation 5, accessories for gamers and physical media games, both new and used. It has no presence in Brazil.
Why are they talking so much about GameStop and WallStreetBets?
A community on Reddit called r / WallStreetBets organized to raise GameStop’s prices, because many large investors were betting that it would fall. Using brokerage apps, participants were able to move the market, taking the stock from $ 18 to a high of $ 483 – an increase of 2,500% this month alone.
Elon Musk, owner of Tesla and SpaceX, gave a hand by posting a link to this Reddit community on Twitter. (He also hates short sellers because Tesla was a major target in the past.) And Tyler Winklevoss, a bitcoin investor, expressed his support; he and his twin brother Cameron hired Mark Zuckerberg to develop the precursor to Facebook, and sued him for stealing his idea.
How did individual investors manage to move a share price so much? Don’t big companies have more power, because they have more money?
Community members on Reddit focused on GameStop because there was an impressive amount of investors who were betting against the company. It has 69.7 million shares being traded on the New York Stock Exchange; at one point, bets that the price would fall involved 71.2 million shares.
There was the opportunity: if the stock price went up, big investors would have to undo these bets, making GameStop appreciate even more.
I know you can buy a stock, but how do you bet against an action? How does short selling work?
In fact, there is no way to have a negative number of shares; but it is possible to operate short positions, which is called “short selling” (or “staying short”).
To make money on any financial asset, it is usually worth saying “buy low, sell high”. Short selling changes this order: you sell at a higher price to (re) buy when it is lower.
Basically, you borrow someone else’s stock and sell it on the stock exchange, signing a contract with a return date and rental interest. After a while, you will need to buy it back: your bet is that it will cost less than what you sold.
And if this bet goes wrong, is this “short squeeze”?
Exact! Suppose the investor borrowed a GameStop share, sold it on the stock exchange, and saw that its price soared. To avoid even greater losses, it is necessary to repurchase this action – which stimulates the price to increase again.
If everyone has the same idea, it can quickly become a snowball: the more people who want to buy the GameStop stock, the more its price goes up – due to the law of supply and demand – and the more short sellers will want to give up the bet . This is how “short squeeze” occurs.
Did Reddit investors have that much money to buy shares?
Some of them were using call options, which may be cheaper than shares.
What are call options?
The put option is a contract in which you agree to acquire a share at a certain price in the future. It is a way of betting that this action will appreciate. Check out the example below:
- the shares of the company TCNBLG cost R $ 10, and an investor thinks that they will increase to R $ 30 in a month;
- another investor has higher expectations, and believes that they will rise to R $ 50;
- this investor makes a contract (call option) to acquire the share for R $ 30 a month from now, and if it goes up more than that, he pockets the profit;
- if this investor changes his mind, he can resell the contract (the call option) to someone else.
Wait, you can resell a bet?
Yeah! The call option is a derivative, because it derives value from another asset (the company’s shares). Derivatives are also traded on stock exchanges.
For small investors, the option may look attractive because it costs less: for example, a GameStop stock now costs around $ 230; purchase options cost $ 0.01 to $ 32.
There are several options for the same stock, each targeting a different target price: some people think GameStop will plummet to $ 0.05, while others see it reaching $ 200.
So what is the disadvantage of the option?
It is much more risky. Think about this: the share price reflects, at least in the long run, the company’s value. Meanwhile, the option price basically reflects the value of its bet – which can tend to zero.
To give a more concrete idea: GameStop’s stock fell 32% between yesterday and today, while some options involving the company plummeted to 87.5%. Of course, the risk may be worth it: the most profitable options rose up to 33% in that same period.
Is it because of this volatility that brokers are limiting transactions involving GameStop?
That’s what they say. R / WallStreetBets users have teamed up to create a short squeeze using home broker apps like Robinhood and TD Ameritrade, which allow individual investors to transact with a zero fee or low commission.
Now, Robinhood only allows you to sell positions (whether stocks or options) of GameStop, BlackBerry, Nokia and other companies that have been short-sold by major investors.
Last year, a 20-year-old boy took his own life after thinking he had lost $ 730,000 by trading options through Robinhood. In fact, the app sometimes showed a negative balance until the transaction was fully finalized. (The company has changed the interface so that it doesn’t happen anymore.) If this happened because of a confusing interface, what could happen when the GameStop price returns to normal?
Still, there was a sense of injustice, because they only limited small investors: millionaire and billionaire funds are free to trade as they wish.
Can Robinhood do that?
That’s what we should find out soon. Democratic MPs Rashida Tlaib and Alexandria Ocasio-Cortez (also known as AOC), as well as Republican Senator Ted Cruz, expressed support for an inquiry in the U.S. Congress to understand why Robinhood restricted his clients.
“Now we need to know more about Robinhood’s decision to prevent retail investors from buying shares, while hedge funds can freely trade shares as they see fit,” writes AOC on Twitter. “As a member of the Financial Services Committee, I would support an audience, if necessary.”
And what did the SEC, the US Securities and Exchange Commission, do about it?
For now, the SEC appears to be concerned about GameStop and other companies’ sudden rise.
“Officials from the SEC and other agencies are looking closely at Internet chat rooms for signs of possible market manipulation, although they can do little if there are no clear signs of fraud,” explains New York Times. “If a large group of traders simply decide to buy stock options at the same time, openly, just because they want to, proving bad faith can be difficult.”
Reddit users disliked this, telling SEC investigators: “go *****”.
It seems that this is just the beginning of a much bigger movement, in which small investors can move prices and challenge huge investment funds.
For example, the Melvin Capital Management fund, which was betting heavily on GameStop’s decline, started the year managing $ 12.5 billion in assets – but its profitability until last Friday was negative 30%.
Billionaire Chamath Palihapitiya tells the CNBC that “this phenomenon of [investidor de] retail is here to stay; there are 2.7 million people within WallStreetBets, and I think they are just as important as any hedge or collection of hedge funds ”.