News Archive

Faculty Insight: What is going on with GameStop?

By Jamie Boyle

ST. PETERSBURG (March 8, 2021) -- What is going on in the stock market? We keep hearing the names GameStop, Robinhood, Reddit, but what does it all mean? In what seems to be a never-ending saga of updates, we have turned to our faculty experts, Professor Daniel Bradley and Professor Leo Chen to give us their perspectives.

Q. What happened with the stock value of GameStop?

A. Daniel Bradley: GameStop was a heavily ‘shorted’ stock, meaning that many market participants were betting against it causing its stock price to be depressed. Shorting companies is typically a strategy employed by sophisticated investors, i.e., Wall Street hedge funds. Individual investors banded together in one of the Reddit online forums, WallStreetBets, started a crusade to ‘stick it to the hedge funds’ by buying GameStop. By taking the opposite trade of hedge funds (buying the stock) it would cause the price to increase. More buy demand pushes the price up and losses start building for these investors betting against it. At some point to limit losses, these short investors get ‘squeezed’ and have to buy shares to close out their short position. This causes the price to rise even further. GameStop isn’t the only company they targeted – other heavily shorted companies like AMC, Bed Bath & Beyond among others were as well.

A. Leo Chen: GameStop stock price went up over 20X in just a couple of weeks. There were multiple days when the stock doubled. Those days are abnormal by any standard.

Q. What started this movement in Reddit?  Has this ever been done by individual investors before?

A. Daniel Bradley: The architect of this movement was led by Keith Gill, a mid-30s former employee of Massachusetts Mutual Life Insurance. He has a cult-like following on Reddit and YouTube. Just last week he testified to Congress about his role in the madness.

I have never heard of such an orchestrated movement by individual investors, especially of this scale. There have been many ‘pump and dump’ schemes where someone (or a small group) will take a position in a company and ‘hype’ it with misleading optimistic information causing the price to increase. They then sell before the other investors do and profit. These schemes usually play out in obscure penny stocks. GameStop was different. It was the result of the perfect storm – 1) the pandemic - many people with extra time on their hands, working from home coupled with very limited sports betting; 2) technological innovations – give rise to a flood of new investors making stock trading so easy (a few clicks on a smartphone to open an account and trade), ‘free’ (it’s not really free), and an explosion in social media platforms that have more daily followers than Tom Brady fans and haters combined; 3) a character with a quirky personality and some credibility because he was making lots of money (even if it was due to luck) and 4) rising asset values inflated by the Fed’s desire to pump money into the market coinciding with stimulus checks being invested for many Americans that didn’t have an immediate need for the funds.

A. Leo Chen: The Reddit discussion board “WallStreetBets” is a forum where individual investors can join and discuss the stock market. After being provoked by the short report on GameStop by Citron Research, WSB participants decided to take on the short sellers, which eventually turned into the biggest short squeeze done by retail investors in history. Nothing with this magnitude had been achieved by retail investors before.

Q. In simple terms what is Robinhood's business model?  How did this contribute to the issue with GameStop?

A. Daniel Bradley: Most of their revenues come from payment from order flow and interest on idle cash. For instance, you open an account on Robinhood and place $1,000 in your account. They lend out that cash and make money on it. After a few days, you place a trade to buy one share of Tesla on their app. Rather than this trade being routed to an exchange for execution, it is sent to a market maker (like Citadel) which is willing to pay to execute that trade. It’s likely the client could have received better execution prices if routed elsewhere (hence, why trading is not free).  They have some premium services as well they charge for.

Their business model didn’t contribute the issue with GameStop per se. What many of these individual investors are upset about is Robinhood (and other brokers) placing trading restrictions on GameStop and other extremely volatile ‘meme’ stocks to meet capital requirements. Individual investors were furious because they claim Robinhood was playing into the hands of Wall Street and these restrictions caused the price of Robinhood to plummet. However, in retrospect, it likely saved many of its clients that wanted to buy near its peak a substantial amount.

A. Leo Chen: Robinhood uses a free commission model to attract individual investors. But there is no free lunch. They send all their trades to Citadel and receive rebates. Robinhood banning GameStop trades helped the short sellers from having even bigger losses. Ironically, Robinhood was a figure portraying someone helping the poor, whereas this Robinhood is helping the wealthy.

Q. Tell us a little bit about shorting stocks?  Who shorted the GameStop stocks and how were they impacted by this?

A. Daniel Bradley: When you short, you sell a stock you don’t own by borrowing it from your broker with the intent to buy it back in the future. For instance, suppose you thought GameStop was overvalued at $400 a share. You could initiate a short position where you sell it at $400. That cash shows up in your account. Suppose the stock falls to $100, you are satisfied, so then you cover your short position by buying it back at $100. You made $300 per share. However, if it goes to $1,000, you lost $600 per share. In theory, losses are potentially unlimited (because there is no cap on how high a stock can go, but there is a floor on how low it can).

A. Leo Chen: Short is virtually selling stocks by borrowing first and repaying later at hopefully a lower price. The major short sellers on GameStop were the institutional players including big hedge funds such as Melvin Capital. Their aggregate losses were estimated to be more than $20 billion.

Q. Do you see this becoming a more regular occurrence?  How will the regulators react to this issue?

A. Daniel Bradley: As much as I would like to say no, as I write this after I thought the saga was over, GME is up over 100 percent today to close at $91.71. In the after-hours market, it is up almost another 100 percent to $175. If it gets to $350 again, I just might short it.

A. Leo Chen: The lack of regulation was partially the reason this type of event could happen in the first place. It would be difficult to imagine the regulators would leave the grey area unregulated in the future, even though publicly discussing stocks is legal. Another contributing factor was hedge funds wrote naked shorts, which is illegal. It will be unlikely another event of this size could happen again soon, if not at all.

Q. Will these trends have a lasting impact on the market?

A. Daniel Bradley: Only time will tell. There are newly created firms whose sole purpose is to monitor developments on Reddit (and other social media platforms) and attempt to profit off the sentiment of the posts and comments. As more people turn to Reddit and other social media sources, the less likely any valuable information can be exploited on it in timely fashion. This is reminiscent of the so-called internet bubble of 1999-2000 that created a new wave of investors. Online trading was a new financial innovation, day trading shops equipped with computers and high-speed internet were opening across the country, and any company with a .com on its name could go public even if was hemorrhaging cash and double the first day of trading. That didn’t end too well.

A. Leo Chen: Short sellers have learned their lesson. Hedge funds weren’t required to disclose their short positions in the first place. If short sellers had kept their mouth shut, this might not have happened. We probably won’t have as much information about shorts as before. Brokerage firms will likely face higher capital requirements by regulators.

Q. Any final comments?

A. Daniel Bradley: While following GameStop, AMC, Bed Bath and Beyond, and other ‘meme’ names is entertaining to watch, it is by no means investing. It’s legalized gambling - and in the long-run, the house always wins.

A. Leo Chen: This is a lottery event for retail investors. One shouldn’t fall into the belief that making money is that easy in the stock market. I like to tell my students that just because someone somewhere is winning lottery every week, it’s easy to win lotteries.