GameStop is a retail physical store chain that sells video games, consoles and collectibles. They also sell used video games.
Melvin Capital, and Citron Research participated in an attempt to short the GameStop stock (GameStock), citing the company’s obsoleteness due to video games being available and downloadable from the internet. A short refers to the practice of borrowing a stock, then selling it, assuming that by the time you’ll have to return it to the original investor, you will have bought it at a lower price than the original. If you perform a covered short, you keep some of the stock in reserve, to cover some of your losses, in case your prediction was wrong. However, Melvin Capital performed a naked stock, selling all the GameStock they had borrowed, thus exposing themselves to further risk, expecting a higher reward. This is the same hedge fund that attempted to sort Tesla a while ago...
The r/WallStreetBets subreddit saw that as an opportunity, given the risky nature of a naked short, and the fact that more than 100% of the stock was shorted. They thus stated purchasing call options, driving the price up, and causing Melvin Capital to lose billions in the process to cover their position. This is referred to as a Short Squeeze. Some of it was about sending a message. A lot of people have lost their jobs during the pandemic, adding to the people that lost their jobs in the 2008 housing crisis. A lot of people are using their extra time to read up on those things. All this information was public. The amount of shares that was short was available. They decided, why don’t we make trades out of this information? And they did. Thus, a full blown war between Institutional Investors and Retail investors began, as the latter beat the former at their own game, causing them to take a huge loss.
Media and institutional investors have called for regulation, arguing that WSB participated in price manipulation. If large hedge funds gathered their forces and coordinated an attack against a stock, they would be fined by the SEC. But how coordinated is an attack by a group of people on the internet? They have not entered an agreement to do something, it’s a whole bunch of small positions. The SEC could not possibly fine and imprison 4m people. Robinhood has restricted customers from buying Gamestock, which has been interpreted as an attempt to cover the losses of Citadel, the company through which they are routing most of their flow, which has invested in Melvin Capital.
Although everything might have change at the time you’re reading this, this story is of high significance for two reasons; firstly, it is the first documented time retail investors are able to beat a hedge fund, utilizing their numbers. Secondly, especially after retail brokers have forbidden retail investors access to certain companies, the importance of Decentralized Finance (DeFi) is further underlined. A system that lacks central authorities, also lack the controls and limitations imposed by such a centralized system.
