Last week, my grandma Facetimed me to ask what a stock short was. Gamestop's stock became a battleground in the fight between Reddit day traders vs. legacy hedge funds.
Like with most epic tales, this event was a long time coming, and today we'll look at some of the long term events that led up to last week and what the fallout may be.
📰 Headline Translator
Breaking down this weeks biggest stories
Oil is Still Struggling
British Petroleum earnings reflected that fuel sales are still struggling. Fuel usually shines in Q4 due to cold weather and holiday travel, so these weak numbers signal that recovery for the industry will be slower than expected. Exxon earnings will likely be just as ugly, and there is some chatter that they are in talks to merge with Chevron.
There is a Shipping Container Shortage
Americans have been buying a lot of stuff. Since restaurants, salons, and travel have been hampered throughout the pandemic, we have turned our spending to acquiring more goods. Since the majority of our goods are manufactured in Asia, and there are only about 180 million containers worldwide, there has been a 300% jump in the price of shipping containers.
We're Getting Earnings from the A-Team
Amazon, Alphabet are due later today. Amazon may get a Prime Day boost but struggle with pandemic costs, while Alphabet may get an ad sales bump. Alibaba's revenue is expected to beat expectations, along with Peloton and other product-based companies.
🎯 Not Just A Game
ICYMI, (which honestly, how??) a group of stock traders on Reddit sparked the greatest short squeeze in financial history. After discovering that Gamestop stock was being heavily shorted by hedge funds, they decided to drive up the price of the stock and watch them squirm. It worked a little too well, and the stock price jumped over 1150% in less than 10 days, best illustrated by the pic below. Hedge funds lost billions, platforms cut off trading, and meme makers had a heyday. If you want more details about what went down, John did a few episodes while it was all going down. Let's take a closer look at all the fuel that contributed to this fire.
🎲 Gamestop Wasn’t Random
Although it's fun to think that Gamestop blew up just because people were nostalgic for getting ripped off for game buybacks, this run on the dying gaming retailer was an event almost two years in the making.
This all really started in September 2019, when legendary investor Michael Burry (think Christian Bale’s character in ‘The Big Short’) bought over $17 million in Gamestop stock, citing that it was undervalued. His reasoning was that despite digital downloads, most of their retail locations were still staying in the black, and their customer loyalty program still had over 50 million dedicated members. This kicked off early chatter on Reddit, where he has a cult following of dedicated fans.
This past August, the founder Chewy and e-commerce expert Ryan Cohen bought a big position in Gamestop and talked about his plans to modernize the company. Then in January 2021, Gamestop officially appointed him to their board of directors with the goal of vamping up their online presence.
The final kicker that sparked this fire? Synthetic shorts. John discusses on the podcast about how this all started because Redditors triggered a short squeeze, but the reason it triggered such drastic losses from hedge funds is because they were holding synthetic positions, meaning they were betting more money than they had. It's similar to playing poker with $200 worth of chips when you only have $100 in your pocket. When Reddit traders saw that they were holding 120% short positions, they knew the stock was ripe for a short squeeze.
💪🏼 The Power of Reddit
One of the most amazing things about what happened last week was that it never could have happened without thousands of people participating. The subreddit that sparked it all, /wallstreetbets, was created in 2012 by an IT consultant who was getting into day trading and wanted “a place for people to talk about high-risk trades and make some short term money with disposable income".
By 2020, the subreddit has gained over a million subscribers and was full of novice traders all talking about their gains, losses, and ideas. Over the course of 2020, users have been posting about fortunes made from Tesla trades and other ‘meme stocks’ or investments made that don't make sense by traditional metrics but simply catch-on online.
Come to January 2021, with the pandemic raging and financial instability abound, the sub has grown to previously unimaginable heights. It gained over two million subscribers in a few days and is generating more comments and posts in one day on the entirety of Reddit. It all came to a peak last Tuesday when Elon Musk tweeted about the forum to his 44 million followers, driving even more momentum around the Gamestop rally.
🤔 What Comes Next
The Securities and Exchange Commission(SEC) is the Federal agency in charge of regulating trading and financial markets. After the extreme volatility of last week, lawmakers are already calling for them to step in and impose restrictions on trading and shorting to prevent this from happening again. A few ideas being discussed are:
Short Caps: Currently, hedge funds have no leverage requirements when they take short positions. That’s what allowed them to take synthetic positions that caused this event in the first place. Lawmakers are talking about imposing leverage restrictions on hedge funds, hampering their ability to go beyond their available capital.
Trade Tax: Another solution that is being discussed is imposing a small tax on stock transactions, to de-incentivize short term trading. We don’t know exactly what this would look like quite yet, but it would likely be aggressive and could harm small traders like you and me.
It remains unclear when Gary Gensler, President Joe Biden’s pick to chair the SEC, will be confirmed to his post, but if he is, the agency has already committed to taking decisive action to prevent events like this from happening again.
🗓 Coming this Thursday…
We have to address the final piece of this whole event, Robinhood. The platform made headlines on Thursday when they, along with a few other platforms, restricted trading in AMC and Gamestop to only allow users to sell, not buy.
There has been a lot of speculation as to why Robinhood took such a bold move, and on Thursday we’ll take a look at what really happened. Want a clue? Check out the word of the day.
Word of the Day
(n.) The ratio of how much you owe to how much you have.If you have $300 in your saving account and have a loan of $900, your leverage would be 3:1.
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