Unless you’ve been living in a remote mountain village with no connection to the outside world for the past year, you’ve heard of the GameStop fiasco. The U.S.-based company is a major player in the gaming merchandise, consumer electronics, and video gaming market. When the stock fell on hard times in 2020, a group of social media high-risk investors took notice.
The fallout led to one of the biggest financial stories in years, confused politicians, a social media mess, and a whole new set of proposed regulations on short selling, the order technique that was at the crux of the entire debacle. Books, TV specials, and Hollywood film proposals came out of the GameStop situation, and the furor has not died down. Here is a short, no pun intended, version of what happened, how shorting works, and other pertinent facts related to the rise and fall of the company’s stock price.
What Happened with GameStop?
Known by its ticker symbol, GME, the gaming company began having financial trouble early in 2020. Some say that online game enthusiasts and platforms were becoming too much of a rival and that the public was slowly drifting away from the in-person play. Add the COVID pandemic into the mix, which meant the shuttering of hundreds of GME stores, and you had a recipe for financial disaster.
Social media risk-takers got in on the action late in 2020 and did something called a short squeeze. In other words, enough buyers got together online and decided to intentionally buy shares of the troubled corporation, thus temporarily sending prices higher. That temporary upswing forced some of the institutional players, mostly hedge funds, to cover their short sale losses by purchasing more GME stock. Prices continued to rise, with many of the social media buyers selling and making a quick profit during the upsurge, when it reached $347, having been at the $17 mark at the beginning of the year. Eventually, prices settled back around the $150 point after a roller coaster ride between $50 and $250 for the first months of 2021.
How Shorting Works
The key to understanding the entire GME situation is to know how short selling works. Here’s a short-selling example that gives an overview of the technique. Short selling has been around for more than a century, but after the Great Depression of 1929, when global securities markets crashed, many countries put regulations in place that regulated the activities of short-sellers. But today, it’s still fully legal to short security if your brokerage approves your account for this kind of transaction.
Suppose you think that ABC Corp. stock is ready to fall, based on your own analysis. If the current share price is $100 and you envision a drop to, say, $70, you could sell the stock short. Here’s how. Find a willing buyer, someone who wants to add ABC to their portfolio. In a global marketplace, it’s usually easy to find at least one person who will agree to buy from you.
You and your prospective buyer sign a trade contract in which you agree to deliver some set number, let’s say 200, shares on a specified date, let’s say one week from today, for a fixed price, assume $105 per share (your customer is assuming that the price of ABC will rise). Now, you are financially and legally obligated to sell 20 units of ABC to your buyer, next week, for the total sum of $2,100 (20 x $105). If your inclination was correct, and ABC falls to $70 before next week, your required delivery date to your new buyer, you simply go into the open market and purchase 20 shares for $1,400 (20 x $70). On the delivery date, you give them to the buyer, who in turn pays you the agreed-upon price of $2,100. Your profit: $700 ($2,100 minus $1,400)
The New Laws
Government regulators detest a chaotic market. The large hedge funds that lost tons of money on the GME situation have well-paid lobbyists who pressure national governments to keep the public from interfering in their profit-making schemes. That’s why so many politicians are proposing rules to restrict individuals from selling short. The two main laws that are likely to be enacted include one that restricts traders from selling short while stock is falling. This uptick law would only let you sell short if the last posted price change of security was positive. The second proposed rule is one that would restrict short selling to approved account holders. Brokers could be pressured by laws like these to simply disallow shorting altogether. The upshot is that the hedge funds win and individual investors lose.
The post New Laws Coming on Heels of GameStop Volatility appeared first on Financial Market Brief.