The news cycle has been dominated recently by a surge in the price of GameStop’s stock. In a matter of weeks from January 11th to January 27th, GameStop shares surged 1,600%. Over the past year, the price is up 5,500%. Considering the fact that GameStop’s business has been struggling for years and they were hit incredibly hard by the pandemic, this surge in their share price is perplexing.
This article will quickly break down what’s happening with GameStop stock and the stock market.
The context
To understand what’s going on with GameStop, it’s important to understand how stock prices fluctuate. Stock prices are dictated by the free market which means that more people buying a stock will drive the price up. On the other hand, if lots of people are selling a stock, it will drive the price down.
The number of people who are buying or selling a stock is usually determined by the news. For example, if GameStop announced that they were launching a digital video game streaming service (like Netflix) that might encourage people to buy the stock and drive the share price up.
Or, if GameStop announced that they were closing down more of their stores then more people would likely sell the stock, which would drive the price down.
However, in rare cases, a coordinated group of buyers or sellers are able to impact a stock’s share price by all buying or selling at the same time.
To help explain, let’s introduce some of the main buyers and sellers.
Main buyers and sellers
To fully understand the game that is being played, we need to introduce a few of the main people buying and selling GameStop:
Melvin Capital – Melvin Capital is a billion-dollar hedge fund ran by Gabe Plotkin. In the same sense that Walmart is “big business”, hedge funds are “big money”. This means that they have billions of dollars to spend on buying or selling assets, like stock.
Wall Street Bets – The Reddit group responsible for the surge in prices. This group is composed of about 3 million “average Joe” investors. These are people who only have a few thousand dollars to invest and were most likely let go during the coronavirus pandemic.
Robinhood – The brokerage that the majority of Wall Street Bets traders use to buy and sell stocks.
Now let’s take a look at how the situation is playing out between these three parties.
How does short-selling work?
When you buy a share of stock, you are usually hoping that the price of that stock will go up over time. However, if you are expecting the price of a stock to go down then you can do what is called “shorting” a stock (also called short selling). The process for investors who want to short sell a stock looks like this:
- The investor who wants to short a stock borrows the stock from another investor.
- They then sell that borrowed stock at the current market price.
- They wait for the stock price to decrease and then buy back the same number of shares, which they return to the person they borrowed from. Their profit comes from the difference between what they originally sold the shares for and what they bought the shares back for.
While there is nothing illegal about short selling, it also means that you are rooting for a company to fail, which leads to unemployment. It’s also worth noting that when you short a stock, your potential losses are unlimited (because the share price of the stock can technically just keep increasing).
Now let’s get to the conflict.
Why is GameStop’s price surging?
Over the past couple of years, Melvin Capital has been “shorting” GameStop’s stock, meaning that they have been rooting for it to fail so they can profit off of the falling share price.
While they have mostly been right that the price would go down, they got a little bit overconfident and shorted so many shares of stock that they put themselves in an incredibly risk position.
One group of savvy traders (the people from Wall Street Bets) noticed Melvin Capital’s risky short position and decided to take advantage. They realized that if they bought GameStop stock and the share price went up, Melvin Capital would be in world of hurt. This is because, eventually, Melvin Capital needs to buy back shares of GameStop stock that they borrowed
Since Melvin Capital has shorted millions of shares of stock, this repurchase will drive the price up significantly.
Mostly, the Wall Street Bets investors are buying GameStop stock because they know that Melvin Capital will need to buy the shares back from them at some point. They don’t necessarily think that GameStop is an incredibly valuable company
How it’s going
Right now, the GameStop stock price is hovering around $225.00 per share, although it has swung between $470 and 132 over the past few days. This means that Wall Street Bets investors and Melvin Capital are essentially in a standoff.
As the price goes up, Melvin Capital is losing billions of dollars and Wall Street Bets investors are making money. However, if too many Wall Street Bets investors start to sell their shares then the bubble will burst and Melvin Capital will make money when the price crashes back down.
However, since Melvin Capital has to buy the shares back, Wall Street Bets investors know that if nobody sells their stock then the price will keep going up and Melvin Capital will eventually be forced to fold and buy at a higher price.
However, since Melvin Capital has to buy the shares back, Wall Street Bets investors know that if nobody sells their stock then the price will keep going up and Melvin Capital will eventually be forced to fold and buy at a higher price.
To start the first week of February, GameStop was down 30%. However, this situation is still ongoing.
We hope that you have found this article valuable when it comes to understanding what is happening with GameStop’s stock price. If you are interested in reading more, please subscribe to get alerted of new articles as we write them!
