Explaining The GameStop Stock Drama

A tale of Reddit users, hedge funds, and short squeezes.

By Robert Marrujo. Posted 01/27/2021 19:20 Comment on this     ShareThis

If you’ve been monitoring the news over the past few days, you might have seen that GameStop stock prices are soaring. Which means you will likely have also noticed that there’s something unusual about this surge, particularly given that it wasn’t all that long ago that bankruptcy was staring the video game retailer right in the face. So, what has led to such a dramatic turnaround? Buckle up folks, this is a wild one.

At the start of 2021, investors began targeting GameStop stocks for something called short selling. This practice revolves around borrowing stock from another investor and selling it, with the objective being that the stock price will plummet and then the seller buys it back for less than they spent on it initially. For instance, if a stock were worth $10 at the time of sale but then later dropped to a worth of $1, the short seller would pocket $9 and then return it to the party that lent the stock in the first place. In the case of GameStop, this seemed a sure bet given the tenuous financial state the company has been in of late.

Enter Reddit, specifically the subreddit page r/wallstreetbets. The users here noticed that some Wall Street investors had begun aggressively short selling GameStop stock and decided to intervene with something called a “short squeeze.” Basically, the risk of a short sell is that the value of the stock will rise instead of fall, which will in turn mean that the short seller has to make up the difference in cost. A short squeeze is when other investors step in and drive up the cost of the short sell stock, forcing the short sellers to buy the stock before losing massive amounts of money on their investment. The r/wallstreetbets community has done exactly that with GameStop shares in an effort to both make some money and screw over the Wall Street investors.

In early January of 2021, GameStop shares were going for roughly $20 a pop. As of the time of this writing, the shares are now going for nearly $348 apiece. To quote Keanu Reeves… whoa.

Major investment companies are reeling from this short squeeze. Hedge fund Melvin Capital is one such example. As stock prices for GameStop surged, Melvin found itself in desperate need of financial intervention to remain solvent. Steve Cohen, billionaire hedge fund manager and majority owner of the New York Mets baseballs team, injected $2.75 billion in equity via his company Point72 Asset Management and the aid of another external party. Cohen has an approximate net worth of $14 billion, but no one sneezes at $2.75 billion. In short, this GameStop business is pretty serious and pulling in some heavy financial hitters.

It’s all giggles from the outside looking in, but there are serious long-term ramifications at play that some folks are arguably not thinking about (or are even aware of). This could prove good for GameStop if it plays its cards right; the retailer has ambitious restructuring plans in place that it is hoping to execute which could theoretically be expedited with this sudden cash injection. However, this is clearly an artificial bubble that is highly more likely to burst at some point than remain inflated. There’s a lot of money to be made by some, but others stand to lose everything.

Regardless, talk about an interesting turnaround for GameStop to start 2021. As we learn more about this situation we’ll continue to update you all. Before we sign off, we caution anyone looking to jump in on this action to be very, very careful and do a ton of research before acting, if at all.

Source: CNBC

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