Individual investors helped to value the retailer’s shares GameStop almost 2,000%, causing a loss of more than US $ 5 billion for those betting on the price drop. O Reddit is having access problems on Wednesday (27), as well as home broker apps that allow you to make transactions for free or at reduced rates, including Robinhood, TD Ameritrade and E * Trade.
What is short squeeze?
GameStop is a chain of stores dedicated to selling consoles and games on physical media, both new and used. A huge number of investors are betting against the company, which had difficulty adapting to online sales. It has 69.7 million shares being traded on the open market, while bets that the price will fall involve more than that – 71.2 million shares.
Typically, an investor buys shares and makes money when they value. It is also possible “Get sold”: that is, you only win when the price drops. If you anticipate a devaluation, you can profit that way.
This involves two steps: first, you rent a share, by means of a loan agreement involving repayment term and interest payment. Then, you sell this stock to anyone who is interested. That way, you can buy it back at a lower price – because the bet is that it will devalue – and then return it to the borrower.
Sure, short selling can go wrong, as in the case of GameStop. If you are sold on a stock and it starts to rise, the best thing to do may be to buy it back at a higher price and stop the loss. When everyone thinks the same way, we have more buyers than sellers: by the law of supply and demand, the price continues to rise. This is called “Short squeeze”.
What is a call option?
And it is relatively easy to bet on a stock’s high, even without buying it directly. Here, we enter a slightly less intuitive area that encompasses the so-called derivatives: instead of buying a stock, you buy the bet that that stock will rise (usually at a much lower value than the stock itself).
This bet is called purchase option (put option). Here is an example:
- 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.
The option is usually cheaper than the stock, so it can be more attractive to individual investors. However, it carries a greater risk and a greater potential for loss – for example, if you bet on an appreciation but the price is falling, the value of the option tends to zero.
Reddit and home broker apps get unstable
Then home broker platforms like Robinhood come in: this app has changed the market in the US because it allows you to buy and sell options without paying transaction fees. Charles Schwab, owner of TD Ameritrade, was forced to reduce commissions charged to customers; other competitors followed suit.
In other words, a market that in the past would be inscrutable for most people has become much more accessible. Communities like Reddit amplified this effect; just take a look at the r / WallStreetBets voice chat on Discord:
the wallstreetbets discord needs to be heard to be believed.
it’s the modern day version of being on floor of NYSE. pic.twitter.com/QqKIz94yvU
– jpa (@josephpalbanese) January 26, 2021
This is attracting many people with the promise of easy profit through a short squeeze. And it’s not just GameStop: other companies have soared on the stock exchange since the beginning of the year, thanks to the interest of individual investors: we have, for example, BlackBerry (+ 233%); the network of cinemas AMC (+ 544%) and the retailer Bed Bath & Beyond (+ 163%).
This leads us to instability that affected home broker apps due to demand. Robinhood and Fidelity were affected, according to DownDetector, but say they have already solved the problem. Morgan Stanley’s E * Trade did not comment.
TD Ameritrade went further and restricted transactions involving shares of GameStop, AMC and others, which are the target of short sellers and Reddit users in the r / WallStreetBets community.
She claims to Bloomberg that high volume may have restricted access to the mobile app, and asked customers to use the web version. “We made these decisions out of caution amid unprecedented market conditions and other factors,” says the company.