By Jonny Lupsha, Wondrium Staff Writer
Internet users drove GameStop’s stock prices up 2,000% in a matter of weeks, C|Net reported. The move was a response to short sellers betting against the video game retailer and waiting for shares to plummet. Connel Fullenkamp, an economics professor at Duke University, explains.
The stock exchange is a lot more complicated than “buy low, sell high”—except when it isn’t. In January, untold numbers of internet users staged a movement on the social media platform Reddit to buy up massive amounts of shares of GameStop stock, which began the year trading at $17 and peaked at over $400 four weeks later.
Throughout the stock’s meteoric rise, Reddit users seemed just as interested in sticking it to hedge funds and short sellers, who may have lost as much as $19 billion in under a month, according to Business Insider. In the aftermath, Wall Street novices and the public are left wondering what happened.
In an exclusive interview with The Great Courses, Dr. Connel Fullenkamp, Professor of the Practice and Director of Undergraduate Studies in the Economics Department at Duke University, helped explain this compelling story.
Shorting and Squeezing
“Short selling is a transaction that allows you to bet on the fall in price of an asset,” Dr. Fullenkamp said. “The way that you do that is you borrow the asset itself. So in this case, with GameStop, they’re borrowing shares of stock, selling the shares and then hoping the price will go down so they can buy them back later at a cheaper price.”
Dr. Fullenkamp said that when it comes to short selling, sellers “borrow in kind.” In other words, they don’t borrow the shares and give back money; they borrow shares, sell them, buy the shares back cheaper, give those shares back to the owner who lent them out, and work out how to split the difference.
It’s important to note that while short selling is legal, the short seller has to have taken possession of the borrowed shares in order to sell them. Selling first and borrowing after the fact is against the law and is referred to as “naked shorting.”
So what happens if the stock price rises instead of falls? Short sellers have to pay out the difference to the lender. A short squeeze, which happened with GameStop, is related directly to this.
“A short squeeze is a panic on the part of the short sellers,” Dr. Fullenkamp said. “If the price goes up, then you’re going to have to make a quick decision whether you’re going to go back and repurchase the shares and take the loss, or whether you’re going to try to ride it out and hope that the shares actually do fall and that you can actually make some money off of this thing.”
With a short squeeze, people like Redditors know there are sellers who have been shorting assets like stock shares and they intentionally drive the cost up to turn the tables and encourage a panic by short sellers, which often drives the price even higher. This was made possible by the sheer volume of people buying small amounts of GameStop stock.
Adding Insult to Injury
The losses in share profits weren’t the only thing making short sellers and hedge funds blanch over GameStop.
“The short position is also leveraged, so you’re borrowing shares but you’re also borrowing money to post as the collateral,” Dr. Fullenkamp said. “Leverage is a returns multiplier, so it multiplies your gains but it also multiplies your losses. As long as these individual traders were holding discipline and acting together, they could continue to drive the price up and cost these shorts.”
GameStop has been in trouble for some time. Their business is a brick and mortar video game store in a world of malls that are closing and inventory that’s increasingly moving to online and digital sales. Furthermore, they have few large investors like a larger company would. These factors put GameStop in prime position for both shorting and squeezing.
The story of GameStop’s stock rollercoaster also includes brokerage apps, after hours trading, and the pandemic-induced factor of small-time investors being stuck at home and able to watch share prices change every moment of the day. Wondrium Daily will continue to investigate this story as it unfolds and will cover facets of the short-selling phenomenon in upcoming articles and videos.
This article is the first in a two-part investigative series by Wondrium Daily into the GameStop stock squeeze. Read the second part by clicking here.
Edited by Angela Shoemaker, Wondrium Daily
Dr. Connel Fullenkamp contributed to this article. Dr. Fullenkamp is Professor of the Practice and Director of Undergraduate Studies in the Department of Economics at Duke University. He earned his master’s and doctorate degrees in Economics from Harvard University.