If you hadn’t heard of GameStop, you probably have now! What is going on with the historic “short squeeze” of GameStop’s stock and how is it impacting the markets?

A “short squeeze” on some of the most heavily shorted stocks has been in play for a couple of weeks before exploding into epic proportions this week. It is being billed as a battle between retail traders and the pros as popular Reddit forum participants (Reddit is an online chat forum) collectively moved to buy some of the most heavily shorted stocks.

Using GameStop as an example, what is happening is this: Some large Wall Street hedge funds had huge short positions in the GameStop stock believing that the company would be the next Blockbuster video (ie, on its way to going away). What that means is that they borrowed and sold shares of stock that they don’t own, betting that the shares would go down where they could buy them at a much lower price and make huge profits. They sold the shares “short”.

However, a group of retail investors flooded the stock with buy orders. And when there are more buyers than sellers, the price goes up. As the price started skyrocketing, the hedge funds realized that they were losing big money as they were going to have to buy the stock at a higher price and not a lower one. This forces them to “buy” the stock to “cover their short position” and their buying adds fuel to the fire and results in the price going up more. This can happen even if GameStop does, in fact, go the way of Blockbuster. 

As a result of the short squeeze, GameStop has seen its stock price rise over 600% at its peak just for the week. The gain over the last three weeks reached over 2600%! Incredible!

And GameStop isn’t the only target. The retail traders have been targeting stocks with exorbitant levels of short interest by hedge funds. Floundering companies like AMC Theatres and Blackberry have had similar stories over the past few weeks. It appears as though retail investors have caught Wall Street hedge funds offsides, though there are still a lot of unknowns in this story.

Many questions exist over why regulators let a 140% short position exist in GameStop, or why no other large party took advantage of this lopsided trade before it happened recently. The assumption was made that no other large player existed that could upset this trade. Enter the retail trader rebellion. 

The main concern is that losses from several exposed hedge funds have been mounting. Will these exposed firms be forced to liquidate their other holdings to raise cash to meet margin calls and will that selling cascade and end up being a catalyst for a bigger and more severe sell-off? 

At this point, we aren’t seeing signs of systemic risk or it leading to a broad sell-off from the forced selling here alone as the dollars involved (GameStop’s market cap is only $22bil) are not material relative to the size of the market. One thing for sure is that the Populist movement, present in politics, addressing themes of inequality and anti-establishment is present in this move as well. We cannot say when that movement will end. 

In another twist, many brokerages moved to limit the trading of these securities. While there was an uproar about the integrity of our markets and conspiracy theories about brokerages bending over backwards to help their hedge fund friends, it could be strongly argued there was a legitimate reason for their actions. Due to the unprecedented volatility in those names, DTCC (Depository Trust & Clearing Company), which operates the main clearinghouse for US stock trades, raised collateral requirements from the brokerages. DTCC needed the higher collateral to insure against losses as the two-day settlement left them vulnerable to losses, especially on stocks that can move multiple times over in a day.

Regardless of how this unfolds between the regulators, daytraders, and the overall financial system, our main takeaway is that speculation is running rampant within segments of the market. This has been the case over the past year. Speculation can always continue to increase. As Maynard Keynes famously said, “markets can stay irrational longer than one can stay solvent”. We will stay the course in the market with a watchful eye on the situation and increasing speculation. 

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