The Long and Short of It | A Gamestop Review
In January of this year a story hit the headlines across all major media outlets. A group of traders who were members of an online community called Reddit had coordinated an effort to buy stock in a company called GameStop. GameStop stock had been in decline for several years from a high of $56.63 per share on November 15th of 2013 to a low of $2.80 per share on April 3rd of 2020. (3) The buying was a concerted effort to drive the price of GameStop stock higher, 1600% at its peak, not because of the value of the company but because of the unique position in which the stock was held. GameStop was the most shorted stock on Wall Street in January, having 140% of its shares out-standing shorted. (1) The short interest in the GameStop shares was held largely by hedge funds who subsequently lost billions of dollars. (4)
What Is a Short?
When someone shorts a stock, they pay a small fee to be loaned the stock, with a promise to pay for that stock at a later day for whatever its share price is at that later date. The person is hoping to borrow and sell the stock at a high price and pay for the stock at a later date when its price is lower, pocketing the difference. What if the share price goes up instead of down? Perhaps this story will help:
Last January Mike went into a local clothing store called Cozy Clothier. Cozy Clothier was selling winter coats for $200 each. They had recently advertised a deal where you could pay a $5 fee to take the coat home on loan. The loan contract stipulated that you had to pay for the coat later for whatever the coat was selling for at that future date. Mike planned to pay $5 to take the coat in January, sell it for $200, and agree to pay for it in June when it was sure to be half-off. He would pay $105 for a coat he sold back in January for $200, for a profit of $95. Mike did this with dozens of coats. He was sure he would make a killing in June.
Unfortunately, a group of Cozy Clothier clients found out that Mike was betting against those winter coats. So, in May they started buying up all the winter coats at Cozy Clothier. To offset the demand, Cozy Clothier raised the price and by June the coats were selling for $1000. Not only did Mike owe Cozy Clothier thousands, but the clients now had jackets worth $1000 and could sell them for a profit.
Bringing It Back
In this story, Mike is the hedge funds and those Cozy Clothier clients are the Reddit members. The hedge funds were betting the GameStop stock prices would be falling in the future and so had borrowed massive quantities of the stock, sold it, and were waiting to reap the benefits of a good bet. When the Reddit members began to buy the stock, it sent the prices soaring and the hedge funds had to pay billions of dollars to cover their contractual obligations.
Market Questions and Advisor Clarity
In the days ahead, there will be significant questions that need answered for the overall market, but financial advisors and investors should be struck by the headlines surrounding this situation. The typical headline reads, “Individual Investors Take Down Hedge Funds: A David vs. Goliath Story.” But what is the real story? A better headline might be, “Individual Investors Take Down Hedge Funds: A People Lost Money and People Gained Money Story.” The most important component of the work an Investment Advisor does is the people for whom they do it. When a hedge fund loses 50% of its value the investors are the ones who really lose. The GameStop saga is yet another reminder of the importance of the very basic fundamentals of investing: diversify, think long-term, and find satisfaction in receiving a reasonable rate of return over time with minimal amounts of risk.