I’m trying to make this an easy explainer to a very complex topic with a lot of moving parts. Here we go.

So it’s been a crazy ride the past week. Everyone’s talking about what’s happening to Gamestop. The stock has surged as much as 1700% since the beginning of January and hedge funds betting against the company have lost billions of dollars along the way. So how did this happen and how did it all unfold? This explainer will attempt to explain everything that has happened and will give you updates on the latest news regarding this once-in-a-lifetime event.

September 8, 2019 – The Genesis: DeepFuckingValue’s YOLO Bet

In short, GameStop was a favorite of many users over at the r/wallstreetsbets subreddit as they felt it was undervalued. Reddit user u/DeepFuckingValue first posted his Gamestop call options position on September 8, 2019. 

Call Options

With a call option, you do not buy the stock—but it is just a contract that gives you the OPTION to buy the stock at the strike price at any time until the expiration date. Each option is a contract to buy 100 shares of the underlying stock. This is done to lock in stocks at a lower price if you believe that it will rise in the future. 

But many people who buy call options do not actually exercise the contract to buy the shares. They just resell the contract when the stock price rises. When the stock price rises, the prices of the options also rises.

Back to the Bet

Back to DeepFuckingValue’s YOLO option bet. Essentially, he was betting that by January 15, 2021 (the option’s expiration date), Gamestop’s price will hit at least $8 (the option’s strike price). At the time he posted the screenshot, Gamestop’s stock price was hovering around the mid $5.00 range. 

At that time, he paid $53,556.04 in premiums for his call options and gained $46,433.96 on that thus far. The total value of his Gamestop options at that point was $113,962. Here is the initial screenshot:

From that point on, he continued posting screenshots of his positions on Gamestop monthly. His portfolio size and worth increased every month. A year later, on September 16, 2020, his portfolio grew almost ten-fold, totaling $973, 938.

By December 31, 2020, the value of his option contracts ballooned to $3,183,460. 

By January 26, 2021, the balance ballooned to an astronomical $22,845,639.

And as he kept posting these screenshots, more people in the r/wallstreetbets subreddit started buying into both Gamestop options and actual shares of the stocks.

At the same time that was happening, hedge funds on Wall Street were betting against it (shorting). 

Wall Street Shorting Gamestop

Gamestop was the most shorted stock in the market. At the end of 2020, the stock had a short interest of 260%. That means there are 2.6x more shares of it sold short than there are actual shares of the stock. 

When you are shorting a stock (or short-selling), you are betting that the stock will go down in price. So you borrow the shares at its current price to sell and hope that the price goes down. Then you can return the borrowed stocks (buy to cover) and you pocket the difference. So if you shorted (borrowed) one share of Stock A when it was at $8 and bought to cover (returned) Stock A when it was at $5, then you made $3. But if the price of the stock goes up, then you are losing money because you need to buy the stock at more than $8 in order to return the stock.

In Gamestop’s case, it was a prime candidate for a short squeeze.

The Short Squeeze

As the price began to rise, many of the stock’s shorters were force to buy the stock in order to cover their position and prevent more losses. This in turn brought the price of the stock higher due to increase buying. And as that happens, more shorts had to buy to cover their positions. 

Then things really got heated when /r/wallstreetbets got to work and bought out-of-the-money call options. Out-of-the-money (OTM) call options are options with a strike price that is more than the stock’s current price. u/DeepFuckingValue’s option contracts were out-of-the-money because the strike price of $8 was higher than the stock price’s intrinsic price at the time (mid-$5). The sellers of these contracts were forced to buy the underlying stock in order to hedge their contracts in the event that the stock price reach’s the option’s strike price. And as the stock price rises and gets closer to the contract’s strike price, the sellers were forced to buy even more contracts. As the price of the stock moves closer to the call option’s strike price, the sellers of the options are forced to buy more of the underlying stock in order to make good on their contracts.

David Versus Goliath

As soon as word got out that a bunch of “internet degenerates” from Reddit are making billion-dollar hedge funds lose billions, the wallstreetbets subreddit exploded in popularity.

The longstanding subreddit had a little more than a million users at the end of 2020. But in less than a month, it had added millions more. As it stands right now (January 28, 2021), it has more than 5,300,000 members. 

And as more people saw Wall St. losing, they wanted to join in on the battle. 

So many more bought Gamestop stock in order to drive the price up even further.

To many of them—this was an opportunity to show that the small guys can win. This was a big middle finger to Wall St, and to the establishment.

People With Clout Took Notice

As the stock went vertical, people started noticing and the internet was filled with chatter about Gamestop. As high-profile social media users took notice, it drove the price up even further as more people got on the hype train. 

Chamath Palihapitiya, CEO of Social Capital, posted this on January 25, 2021:

Elon Musk Gets Involved

When the stock market closed on January 26, 2021, Gamestop’s stock was at almost $150.

Then Elon Musk tweeted about it…
As soon as that happened, Gamestop’s stock price instantaneously doubled in after-hour trading.
 

Melvin Capital’s Big Loss

Melvin Capital is one of the stock’s biggest shorters. They reportedly loss billions of dollars and had to get a cash injection of $2.75 billion in order to cover their short position. They have reported closed out their short position.

January 27, 2021

January 27, 2021 was looking like another big day for Gamestop.

However, the day became extremely chaotic as brokers, policy-makers, and hedge fund managers became increasingly worried.

Multiple brokerages decided to put restrictions on trading of Gamestop stocks and options.

The White House said they were closely monitoring the situation.

The SEC also put out a statement noting that they are also closely monitoring the situation.

Discord banned wallstreetbets’ channel.

The wallstreetbets subreddit went to private for a few hours.

It was safe to say that it was an extremely chaotic day.

As these things started happening, it spread fear, uncertainty, and doubt in the market and allegations of corruption of the brokerages.

As such, the price tanked after-hours.

January 28, 2021

The events of January 27, 2021 set up January 28 to surely be an ugly day of trading.

Robinhood, Interactive Brokers, and many other brokerages further put limitations on the trading of Gamestop. Robinhood made it so that no one was able to buy Gamestop stocks or options—they could only sell it. 

This led Gamestop to fall 44% for the day—from $347 to $193.60.

This move was widely criticized by many, including both political parties.

When Ted Cruz and AOC agree on something, you know you messed up big time.

Although Robinhood said this was done out of caution for its users, a supposed Robinhood employee wrote on Reddit that this was not so. He stated that it was plain corruption.

Again, this is unverified.

But it wasn’t until the end of the day that Robinhood decide to allow limited trading of the stock again. It is not clear why this was done.

Other brokers have also put some restrictions on trading Gamestop. For instance, here is what TD Ameritrade sent out after the market closed on January 28, 2021.

We don’t know how this will end. But what we do know is that this is far from over. Check back often for updates.

 

References:

https://www.marketwatch.com/story/hedge-fund-melvin-capital-closes-out-gamestop-short-cnbc-2021-01-27

https://www.kiplinger.com/investing/602165/what-exactly-is-a-short-squeeze

https://www.reddit.com/user/DeepFuckingValue/