What Do They Know That We Don’t …. About GameStop
An early February Yahoo-Harris poll said that 9% of Americans bought GameStop shares in January. The same poll revealed that 24% of Americans bought GameStop or another “viral stock” in January. The other viral stocks included the likes of AMC Entertainment and Blackberry, among others. The average investment was $8535. Men in the 18-44 age group were the most likely demographic group to participate. The majority planned to hold the shares less than a month and bought the shares in a brokerage account which was less than a month old. GOOGLE search records revealed that more people than ever before googled “how to buy stock” in the days prior. Hm….
The trading frenzy was sparked by talk on the social media Reddit sub-platform r/wallstreetbets. No one really knows why this happened. Was it boredom, Covid exhaustion, social media frenzy about making a quick buck or some extra cash from stimulus checks or not going out to eat? Or was it a bit of all these things? The good news for small investors: some made lots of money and learned a little about the stock market. The bad news for small investors: some lost a lot of money and learned nothing. What happens to the industry, something we all care about, remains to be seen.
So what really happened, or is perhaps even still happening? Let’s peel it back a little more….
GameStop owns video game stores, mostly in malls. In Aug 2020, the share price was $4 and the total value of the company was $280 million. In January, a few hedge funds decided that GameStop was overvalued and decided to “short sell” shares, which is a common practice of hedge funds.
“Short selling” occurs when an investor “borrows” shares of a stock and then sells these shares which he doesn’t actually own. The investor hopes that the stock will go down in price so he can then buy shares at a lower price, return the borrowed shares and pocket the profit. Now this is all good, until the shares instead go up in price. Now the investor has to buy the shares at the higher price (In this case a much higher price) in order to return the borrowed shares.
In this case, someone on Reddit noticed the short selling of the GameStop shares by the hedge funds and enlisted an army of Reddit loyalists to start buying the shares, which of course drove the share price higher. In this case, the price shot up to as high as $480/share (from $4/share in August) and the company value rose to $33.5 billion from the August value of $280 million. The hedge funds then had to buy the shares at up to $480/share so they could return the ones they sold at $4. Of course, this all also led to a very complicated mess at trading platform Robinhood, details about which I will spare you.
Fast forward to today, the stock is volatile but not anywhere near how it looked two weeks ago, and the criticism and blame is rolling in on all sides. Who knows what will happen? But as we all know, what goes up, goes down.
One more thing…. Some of you who do options trading might have had moments of unrest as you watched this saga unfold, so I want to explain how what we are doing with you is different, to put your minds at ease: The GameStop situation involved the purchase of “uncovered calls.” In other words, the buyers were “uncovered” – they didn’t own the shares they were selling. When we sell calls with you, they are “covered calls” – you always already own the shares you are trying to sell. The worst case with covered calls is that the share price doesn’t get to the pre-determined strike price and you keep the shares – and the income from the sale of the call. Best case is that you sell your shares at the pre-determined strike price and also get the income from the sale of the call. Of course, there are also times when the share price goes up beyond your strike price and you leave a little money on the table! All are ultimately good outcomes!
Next up: Bitcoin, et al