The GameStop Saga

Okay, let’s clear up some definitions first.

GameStop is a video games retailer. Reddit is an online discussion forum. r/wallstreetbets is a particular place within Reddit where people discuss investing – particularly making speculative trades.

Now, GameStop hasn’t been doing too well, especially over the past two years. You can imagine why this might be right now. While gaming itself is booming, fewer people are heading to the shops to buy a physical copy of a game. This trend has only been amplified by the pandemic.

Let’s introduce hedge funds. Hedge funds are companies with huge amounts of money to invest on behalf of their clients. Their clients range from wealthy people to banks. Some of these hedge funds, such as Melvin Capital, felt that GameStop wasn't a sustainable business. They decided to short GameStop.

So, what is shorting?

Normally, when you buy shares, you try to ‘buy low and sell high’. You make money by selling the shares for more than you bought them for. You hope that the company’s share price goes up.

When shorting, you are effectively placing a bet that a company’s share price will go down. You achieve this by borrowing shares and selling them. If the company’s share price goes down, you can profit by buying the shares back at a cheaper price.

Now back to GameStop.

Not everyone thought GameStop was doomed. Since 2019, Reddit user ‘DeepF****ingValue’ had made a series of posts on r/wallstreetbets presenting his case for why GameStop was undervalued. While no one really took notice at first, there were two important events that followed.

First, one fund – Scion Asset Management - announced it had bought three million shares in GameStop. This was a fund led by Michael Burry, renowned for making millions after the 2007 housing price crash. Redditors took note. Why was such a successful investor optimistic about GameStop?

Second, Ryan Cohen, the former CEO of online pet retailer Chewy, announced a large investment in GameStop, believing the company had a future. In an angry letter to the board of directors, he argued that GameStop could and should capitalise on the explosive growth in the gaming sector, but it had to make drastic changes.

Fast forward to this year, and Ryan Cohen and two other investors were appointed to GameStop's board. Members of r/wallstreetbets began to discuss GameStop's hopeful future and started buying shares in the company.

As the number of threads about GameStop increased, Redditors began digging into the hedge funds who had shorted GameStop. How could these hedge funds short GameStop so heavily? How was it fair that they were shorting more GameStop shares than were in existence?

These Redditors had a plan. They knew that if GameStop's share price went up, hedge funds stood to lose a lot of money. They would face a short squeeze, as hedge funds would need to buy GameStop shares to stop their losses mounting, amplifying the price even higher.

So large numbers of Redditors banded together to push up the price of GameStop shares. They used call options - financial contracts that gave them the right to buy shares at a particular price - to amplify the price increase. This is because banks would respond to the purchase of call options by buying shares to cover their own positions.

Put very simply, that's what happened. For many Redditors, they had a cause. This was a chance to make the Wall Street elite suffer. And they did - somewhat - with hedge funds like Melvin Capital requiring a bail-out.

Over last week, as media attention grew, everyone began talking about GameStop. Even more people began buying GameStop shares. For some amateur investors, they wanted in on the chance to turn a small amount of money into thousands, or even millions. GameStop’s share price rose to astronomical levels.

(And then it fell...but that's for another week.)

So what does this mean for you and your interviews?

Here's my advice for you:

First, have an opinion. You won’t be expected to know much about hedge funds, gamma squeezes, or call options. However, you should know enough to share your view on the topic. Try explaining what happened to a friend, in your own words. Why is this topic interesting to you?

Second, consider the direct legal implications. Regulators in the US have made it clear that they are monitoring the situation. Is it manipulating the market to publicly coordinate to increase the price of a share? Where do we draw the line? How is that different from what the hedge funds were doing?

Third, consider the wider implications. One of the big consequences, which I haven't touched on, are the decisions made by third parties. The big one is Robinhood, a US-based trading app that disrupted the industry by making it very easy to buy and sell shares. However, last week, Robinhood made the decision to restrict trading of particular shares, leading to substantial backlash and even class-action lawsuits. Consider, was Robinhood acting lawfully in restricting access to investments? And if they were, could they have handled the situation more carefully?