GAMESTOP SHORT SQUEEZE: A FIRST LINE OF ATTACK ON WALL STREET
GameStop is a typical high street video game retailer whose share price has been floundering for the last six years. The company’s pessimistic prospects were exacerbated by an accelerated shift of the gaming industry online, as a result of the pandemic. This has led to many hedge funds and institutional investors betting on their eventual demise as an almost certain prospect. As a result, around 72 million GameStop shares were shorted before the current bull run, representing 140% of the total capital of the company. Other stocks heavily shorted include AMC Entertainment, Blackberry, Nokia, Bed Bath & Beyond, Beyond Meat and Evotec, against which Melvin Capital held the largest short by percentage of shares shorted on a European company (6%).
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The abundant liquidity and low cost of leverage enabled these considerably risky short positions, leaving these investors to be particularly vulnerable to price rallies, especially a ‘short squeeze’. Retail traders saw an opportunity to collectively buy all of the aforementioned stocks, and enforce a squeeze. As share prices rose exponentially, all short hedge funds were forced to liquidate their positions and buy back the stock they initially borrowed for their shorts, fuelling the rally further.
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Why were call options so significant in GameStop’s rally?
The extensive use of ‘Out-of-The-Money’ call options acted as a catalyst towards the surge in share prices. The particular dynamics of this type of call option entails that if a call strike price is attained, brokers are obliged to deliver the shares and require to hedge themselves too in the process, either by passing on the option contract to another counterparty or entering the market themselves, once again driving the rally further. This surge in options activity with regards to GameStop, shown below, specifically is seemingly unprecedented. The rise in activity has been particularly dominant in trades of smaller magnitude, often 10 call contracts or less, highlighting their strategic use by individual retail investors as opposed to financial institutions.