Last week, an epic short squeeze had driven GameStop stock up to $40 a share, a roughly 1,500 percent increase from its low point nine months ago. Little did anyone know at the time that this would only be the beginning of the story.
As I write this, GameStop’s stock price is hovering around $350, up another 775 percent or so since I wrote about this situation eight days ago. By the time you read this, that number may be horribly outdated, as the stock continues to bounce up and down with extreme volatility hour by hour (it dipped down as low as $61 and peaked as high as $159 on Friday).
The current stock price now gives the company a market cap of about $26 billion.
On the surface, that means the market currently thinks GameStop is worth more than twice as much now (during a potentially existential threat to brick and mortar game sales) as it was during the height of the Wii boom in late 2007, when console game downloads were barely a thing.
It’s an understatement to say that nothing has changed about GameStop’s fundamental business to justify such a quick and dramatic rise in valuation. But getting at what is causing the nearly vertical launch of GameStop’s stock value is a little complicated.
A short lesson on shorts
To understand what’s happening to GameStop stock, first you have to understand short selling, where investors make a bet that a stock will go down instead of up. To do this, they borrow a share of the stock (for a fee), immediately sell it to pocket the current value, and agree to buy another share later to “cover” their short position.
But shorting stocks comes with huge risks if the stock price goes up. When your short position eventually comes due, you’re forced to buy the stock at whatever price the market currently sets, and there’s theoretically no limit to how high it could go. If you invest $1,000 in buying a stock, all you can lose is $1,000. If you borrow $1,000 worth of stock to short it, you could lose a lot more than that when you’re forced to buy much more expensive stock.
Investors as a whole were so sure that GameStop stock was going to go down that they wanted to borrow every single available share (and then some) to make money on the coming collapse.
When investors do lose money on a short position in this way, they often reborrow more short options at the new price to hedge their bet (if they expected the stock was overvalued before, it’s probably even more overvalued now, right?). That “short squeeze” process can theoretically keep going until the stock price actually starts going down (perhaps because traditional “long” investors want to pocket their profits) or the short sellers run out of capital to keep borrowing.
GameStop has been one of the most heavily shorted stocks on the market for a while now. Since the middle of 2019, the “short interest” (i.e., the number of shares investors have expressed interest in borrowing for a short position) has heavily surpassed the stock’s “free float” (i.e., the number of actively traded shares available). In other words, investors as a whole were so sure that GameStop stock was going to go down that they wanted to borrow every single available share (and then some) to make money on the coming collapse. And keep in mind, this phenomenon started when GameStop stock was already trading at historic lows of $5 a share or less.
GameStop faces plenty of headwinds to its core business of selling disc-based games in brick-and-mortar stores (as we’ve written about extensively). But that extreme level of short interest in an already heavily depressed stock was probably overly pessimistic about the company’s near-term prospects.
“They don’t have net debt, so they’re not going bankrupt or anything,” Wedbush Morgan analyst Michael Pachter told Ars last week. “And with the new console launch, they’re probably going to sell a lot of consoles and be fine.”
As it turns out, a group of retail investors noticed this excess of pessimism and was poised to exploit it.
Enter the Redditor
The WallStreetBets subreddit (WSB) describes itself as “like 4chan found a Bloomberg terminal,” and that’s not a bad description. WSB is a generally disorganized mess of posters throwing up memes and slang that can be hard to parse for an outsider. At the center of it, though, are members who analyze the market for opportunities so they can try to rally the sub’s millions of subscribers (2.9 million as of this writing) to a potential value play.
A few posters on WSB began to notice GameStop as a potentially undervalued and overshorted stock back in 2019, without too much wider action. But the group’s attention began to crystallize around April 2020, when WSB member Senior_Hedgehog laid out what turned out to be a prescient case for “the biggest short squeeze of your entire life.”
GameStop stock remained relatively flat in the months following that post. That changed in August, when Chewy.com founder Ryan Cohen bought a 9 percent stake in the company. Since then, Cohen has increased his stake in the company, earned control of three board seats, and promised to try to refocus the retailer into a more purely digital business.
“GameStop’s challenges stem from internal intransigence and an unwillingness to rapidly embrace the digital economy,” Cohen said in a November SEC filing. “If GameStop takes practical steps to cut its excessive real estate costs and hire the right talent, it will have the resources to begin building a powerful e-commerce platform that provides competitive pricing, broad gaming selection, fast shipping, and a truly high-touch experience that excites and delights customers.”
Whether or not that transformation will be possible, the interest from the usually risk-averse Cohen was enough to get some investors to take another look at buying GameStop. The price started creeping up from $5 in the middle of August to nearly $20 by the end of the year. That put some pressure on all those short positions, but not enough to stop them from reborrowing and keeping short interest high.
On Reddit, meanwhile, the hype around the turnaround only got louder and louder as the stock price increased. Some WSB members (and others) posted lengthy analyses suggesting a “fair value” of $100 or more per share for GameStop based on expected earnings (analysts in aggregate suggest a much more modest $13.44 price target based on the fundamentals). Others take a more meme-centric, “for the lols” route, reminding their compatriots that “stocks only go up” and urging “diamond hands” (i.e., hands that never stop holding) and bitcoin-style HODL strategies as GameStop stock goes on a “rocket to the Moon.” Some even encouraged GameStop stock owners to tell their brokers not to allow those shares to be borrowed for further short options, squeezing short borrowers even further (it’s not clear how much effect this part of the effort has had, in aggregate).
Through it all, the WSB-ers have been able to coalesce around a vision of themselves as the “little guy” using cheap retail trading tools to fight against a common perceived enemy: massive hedge funds that were heavily shorting the stock. Citron Research founder Andrew Left, who’s been publicly arguing for a $20 price target for GameStop, said last week he was targeted by a wave of harassment and attempted hacking ahead of a planned video arguing for the short position.
More recently, Melvin Capital Management has seen its value fall 30 percent this month, thanks in no small part to a heavy short position in GameStop. The hedge fund was forced to take a $2.75 billion cash infusion from Citadel to stay solvent in recent days. CNBC reports that Melvin finally closed out its short position Tuesday afternoon, i.e., taking a huge loss rather than redoubling on the short borrowing. But many WSB posters are publicly doubting that report and are confident they can literally bankrupt a massive hedge fund if the GameStop stock price goes high enough.