The story of the beleaguered video game retailer is one for the history books. In many ways, the famous short squeeze that occurred back in early 2021 changed the game forever. A success story no doubt, but not one without its fallen victims. The GME squeeze unveils much about the shadowy nature of institutional finance, while the underlying movement betrays the darker side of investment psychology.
What is GameStop?
Under its current name, GameStop has been around since 1999. The company was ideally situated to capture the growth of the video games industry, expanding massively throughout the early 2000s. Hard to believe for the younger generations out there but back in the old days, if people wanted to buy a book, film or video game, they would actually have to walk into a shop and purchase a physical copy. In North America, GameStop became the go-to place for consoles, games and various collectables. It was also home to a thriving second-hand marketplace, from which the company profited enormously. It was nerd heaven.
Alas, all good things must come to an end. As with many businesses that depended heavily on in-store traffic, the company suffered greatly from the advent of online commerce. Steam, the digital distributor for PC games, officially went live in 2003 and prompted the likes of Sony and Microsoft to open online stores of their own. It would take a while, but by around 2015, the scales would permanently tip in favour of digital sales and would never again favour physical media. The COVID years would accelerate the process even further and by 2023, it was estimated that over 80% of all video game sales were exclusively digital in nature.
Just as Amazon crushed brick-and-mortar bookshops and online streaming services destroyed Blockbuster, digital video game sales had a disastrous impact on GameStop and other video game retailers.
The setup
In 2002, GameStop was listed on the New York Stock Exchange under the ticker GME. The stock fared well initially, but later on prices would start to reflect the company’s financial struggles, with shares falling to lows of $0.70 in 2020. Understandable, given the underlying fundamentals, but the price action was not entirely organic. By late 2020, GameStop was one of the most shorted stocks on the market, with over 100% of its float being shorted. This meant that more shares were being shorted than were actually available for trading – a particularly risky position for those who were short on the stock. This fact did not escape the attention of the subreddit /wallstreetbets, which discovered that investment firm Melvin Capital, among others, were heavily involved.
The internet smelled blood. Our beloved video game store being exploited for financial gain by cold-hearted hedge funds? Not on our watch. Before long, a plan to force a short squeeze on the stock began to take shape.
As a reminder, a short squeeze occurs when the price of an asset rises sharply, forcing those who are shorting to cover their positions in order to avoid getting margin called. This creates more buying pressure, which drives the price to higher levels still, forcing yet more parties to cover their shorts, and so on and so forth, culminating in a drastic increase in price.
The squeeze
The idea was an easy sell. Soon enough, investment communities from the four corners of the internet came together to stick it to the man. Users on Wall Street Bets and further afield started buying GME shares and call options in increasingly high volumes. The high short interest and low float made the stock ripe for the taking. Buy pressure began to mount.
From a price perspective, things kicked off in earnest on Wednesday the 13th of January 2021. GME opened the day at $20.44 and peaked at an intra-day high of $38.64 per share. Commendable, but a mere taste of what was to come. By the 25th of January, GME had breached the $100 mark. Now people were really paying attention. Institutional money had a stake in this game and at this point, it was on the wrong side of the trade. Incredibly, hitting three figures was just the beginning. The buying pressure was relentless. The frenzy continued for another few days until the 28th of January, when GameStop hit $483 per share intra-day and even surpassed $500 in pre-market extended trading. A 2000% gain in a couple of weeks. It was a staggering achievement.
Melvin Capital
The short squeeze would ultimately be ruinous for Melvin Capital. The fund was forced to close its position and by the end of January, it had lost over 50% of its assets. Other hedge funds, including Citadel, would attempt to bail out the firm with a multi-billion-dollar injection of cash but the effort proved to be in vain. Melvin Capital lingered on for a couple more years, but the deathblow had been dealt. In 2022, the fund announced its permanent closure and returned all remaining funds to its investors. The battle was over and the underdog had won.
A fairy-tale finish on the face of it, but there is much more to this story than meets the eye.
Robinhood and the DTCC
A major character in this story, not mentioned until now, is the trading platform Robinhood. With its wide array of commission-free trading options, Robinhood has grown massively over the years and played a pivotal role in the GameStop short squeeze. The platform was the perfect tool to attract retail interest to the movement and users flocked to it in droves to buy GME stock.
The massive surge in buying pressure would not have been possible without Robinhood. With that said, the platform is equally responsible for the sharp decline in GME following the $483 peak. On the 28th of January, Robinhood restricted trading on GME and its customers were barred from buying any more shares. Users could only sell the shares already in their possession. The reason Robinhood did this is because they were facing a $3 billion margin call from the Depository Trust & Clearing Corporation (DTCC).
When trading stocks, it is important to understand that simply hitting the buy or sell button does not result in an immediate swap of ownership. A better way of viewing the trade is that the broker, in this case Robinhood, temporarily attributes the stock to a new user and then passes this information on to the DTCC, which settles everything in the background. At the time of the GME squeeze, this process took two working days (as of last year, it now only takes one). This is an entirely standard practice and allows for a much more fluid user experience. The DTCC is a critical piece of settlement infrastructure, without which modern trading would look very different.
Because of the lag between the broker and the DTCC, brokers have to meet certain margin requirements, as per financial regulations. During the time of the short squeeze, the extreme volatility in GME stock combined with unprecedented buying pressure created massive margin demands from the DTCC, which Robinhood was temporarily unable to match. To address this, Robinhood paused the buying of GME shares and drew on existing credit lines to raise billions in emergency funding. Such measures take time. The company would resume full trading a few days later, but by then the damage had been done.
Without having access to Robinhood’s books, the justification given does in fact appear to be valid, but try telling that to those who bought at $400+. Many a bag holder was created that day. Things get even juicier when considering that Citadel Securities was acting as a market maker for Robinhood, handling a significant portion of the platform’s order flow. Does the name ring a bell? Citadel was one of the hedge funds that bailed out Melvin Capital to prevent it from defaulting following the squeeze. The waters become increasingly murky.
Given the above, it is easy to see why the halt in trading was seen as a way of screwing over retail investors in favour of institutional hedge funds such as Melvin Capital and Citadel. As for why Citadel tried to bail out Melvin Capital, the explanation given essentially boils down to containment. As intertwined as such players are, stopping one domino from falling prevents wider contagion. So the story goes. An investigation was conducted, but to no one’s surprise, no evidence of wrongdoing was unearthed. A hundred arguments could be made either way on this case. Perhaps a more neutral way of looking at these events is that while the likes of Robinhood, Melvin and Citadel did nothing technically wrong, the opaque and incestuous nature of institutional finance leaves retail with an unwinnable battle.
If only some kind of transparent blockchain-based clearing system could be implemented. Wouldn’t that be nice.
Forgotten remnants
The story should probably have ended there, but it did not. Despite the obvious success of the short squeeze, for some, it was not enough. For the die-hard enthusiasts, Robinhood’s controversial actions had doused the fire, which should have raged on to the destruction of far greater players. Justice had not been served.
Almost five years after it all kicked off, there persists a community of investors resolutely committed to the movement. Many within this community believe that the real short squeeze has not yet occurred. The events of January 2021 were just a warm-up. The mother of all short squeezes, or MOASS as it is often called, patiently bides its time.
It is certainly the case that the actions of Robinhood cut the run short. It is also true that short interest on the stock remains high – around 16% at the time of writing. Unfortunately, this is where the rational argument ends and the darker side of investment psychology takes over. The sad truth of the matter is that many GME investors are underwater and have been for some time, which inevitably promotes the deadly sunken cost fallacy. Investors continue to hold onto a losing position because they have already poured significant time, money and energy into it. With every passing day, it becomes harder to let go. Fear sets in but results in no action. Valid concerns are waved away. The communities persist, but the hype gradually fades. Those who remain become increasingly less vocal. An inconvenient truth is that over the last four years, most GME investors would have been better off parking their funds in the S&P 500.
For some, commitment to the cause trumps any notion of financial gain. They are in the movement because they genuinely believe in the cause. The anti-establishment sentiment is more than enough for many people, which is absolutely fair enough. More generally, the online culture that has developed over the years now constitutes a familiar, meme-rich environment that investors far and wide proudly call home. GameStop is not alone in this regard. A number of other stocks have acquired devotees of their own, such as Bed Bath and Beyond (BBBY) and AMC Entertainment (AMC).
GameStop’s legacy
The events surrounding GameStop had a lasting impact on the financial world. In many ways, the GME short squeeze represented a shift in market power from traditional hedge funds to retail investors. Current situation aside, the fact remains that the GameStop community won and Melvin Capital lost. As retail investors gain ever more powerful tools and as markets become ever more transparent, one wonders how many more GME events we will see in the future.
On a dourer note, dedication to a company and its stock price seems like light-hearted fun on the face of it, but runs the risk of turning into something far more worrisome. The biggest problem with remaining steadfastly committed to a given stock is the opportunity cost of doing so. Sticking to a singular asset cuts an investor off from every other opportunity. Unwavering devotion is a noble trait in many circles, but arguably not in financial ones. Do not marry your bags.
Footnote: GameStop executed a 4-for-1 stock split in 2022, meaning all the prices discussed above would need to be divided by four to reach the current pricing.
