The complete moron’s guide to GameStop’s stock roller coaster

Last week, an epic short squeeze had driven GameStop stock up to $40 a share, a roughly 1,500 percent increase from its low point nine months ago. Little did anyone know at the time that this would only be the beginning of the story.

As I write this, GameStop’s stock price is hovering around $350, up another 775 percent or so since I wrote about this situation eight days ago. By the time you read this, that number may be horribly outdated, as the stock continues to bounce up and down with extreme volatility hour by hour (it dipped down as low as $61 and peaked as high as $159 on Friday).

The current stock price now gives the company a market cap of about $26 billion.

On the surface, that means the market currently thinks GameStop is worth more than twice as much now (during a potentially existential threat to brick and mortar game sales) as it was during the height of the Wii boom in late 2007, when console game downloads were barely a thing.

It’s an understatement to say that nothing has changed about GameStop’s fundamental business to justify such a quick and dramatic rise in valuation. But getting at what is causing the nearly vertical launch of GameStop’s stock value is a little complicated.

A short lesson on shorts

To understand what’s happening to GameStop stock, first you have to understand short selling, where investors make a bet that a stock will go down instead of up. To do this, they borrow a share of the stock (for a fee), immediately sell it to pocket the current value, and agree to buy another share later to “cover” their short position.

But shorting stocks comes with huge risks if the stock price goes up. When your short position eventually comes due, you’re forced to buy the stock at whatever price the market currently sets, and there’s theoretically no limit to how high it could go. If you invest $1,000 in buying a stock, all you can lose is $1,000. If you borrow $1,000 worth of stock to short it, you could lose a lot more than that when you’re forced to buy much more expensive stock.

Investors as a whole were so sure that GameStop stock was going to go down that they wanted to borrow every single available share (and then some) to make money on the coming collapse.

When investors do lose money on a short position in this way, they often reborrow more short options at the new price to hedge their bet (if they expected the stock was overvalued before, it’s probably even more overvalued now, right?). That “short squeeze” process can theoretically keep going until the stock price actually starts going down (perhaps because traditional “long” investors want to pocket their profits) or the short sellers run out of capital to keep borrowing.

GameStop has been one of the most heavily shorted stocks on the market for a while now. Since the middle of 2019, the “short interest” (i.e., the number of shares investors have expressed interest in borrowing for a short position) has heavily surpassed the stock’s “free float” (i.e., the number of actively traded shares available). In other words, investors as a whole were so sure that GameStop stock was going to go down that they wanted to borrow every single available share (and then some) to make money on the coming collapse. And keep in mind, this phenomenon started when GameStop stock was already trading at historic lows of $5 a share or less.

GameStop faces plenty of headwinds to its core business of selling disc-based games in brick-and-mortar stores (as we’ve written about extensively). But that extreme level of short interest in an already heavily depressed stock was probably overly pessimistic about the company’s near-term prospects.

“They don’t have net debt, so they’re not going bankrupt or anything,” Wedbush Morgan analyst Michael Pachter told Ars last week. “And with the new console launch, they’re probably going to sell a lot of consoles and be fine.”

As it turns out, a group of retail investors noticed this excess of pessimism and was poised to exploit it.

Enter the Redditor

The WallStreetBets subreddit (WSB) describes itself as “like 4chan found a Bloomberg terminal,” and that’s not a bad description. WSB is a generally disorganized mess of posters throwing up memes and slang that can be hard to parse for an outsider. At the center of it, though, are members who analyze the market for opportunities so they can try to rally the sub’s millions of subscribers (2.9 million as of this writing) to a potential value play.

A few posters on WSB began to notice GameStop as a potentially undervalued and overshorted stock back in 2019, without too much wider action. But the group’s attention began to crystallize around April 2020, when WSB member Senior_Hedgehog laid out what turned out to be a prescient case for “the biggest short squeeze of your entire life.”

GameStop stock remained relatively flat in the months following that post. That changed in August, when Chewy.com founder Ryan Cohen bought a 9 percent stake in the company. Since then, Cohen has increased his stake in the company, earned control of three board seats, and promised to try to refocus the retailer into a more purely digital business.

“GameStop’s challenges stem from internal intransigence and an unwillingness to rapidly embrace the digital economy,” Cohen said in a November SEC filing. “If GameStop takes practical steps to cut its excessive real estate costs and hire the right talent, it will have the resources to begin building a powerful e-commerce platform that provides competitive pricing, broad gaming selection, fast shipping, and a truly high-touch experience that excites and delights customers.”

The YOLO-riffic logo for r/WallStreetBets.

Whether or not that transformation will be possible, the interest from the usually risk-averse Cohen was enough to get some investors to take another look at buying GameStop. The price started creeping up from $5 in the middle of August to nearly $20 by the end of the year. That put some pressure on all those short positions, but not enough to stop them from reborrowing and keeping short interest high.

On Reddit, meanwhile, the hype around the turnaround only got louder and louder as the stock price increased. Some WSB members (and others) posted lengthy analyses suggesting a “fair value” of $100 or more per share for GameStop based on expected earnings (analysts in aggregate suggest a much more modest $13.44 price target based on the fundamentals). Others take a more meme-centric, “for the lols” route, reminding their compatriots that “stocks only go up” and urging “diamond hands” (i.e., hands that never stop holding) and bitcoin-style HODL strategies as GameStop stock goes on a “rocket to the Moon.” Some even encouraged GameStop stock owners to tell their brokers not to allow those shares to be borrowed for further short options, squeezing short borrowers even further (it’s not clear how much effect this part of the effort has had, in aggregate).

Through it all, the WSB-ers have been able to coalesce around a vision of themselves as the “little guy” using cheap retail trading tools to fight against a common perceived enemy: massive hedge funds that were heavily shorting the stock. Citron Research founder Andrew Left, who’s been publicly arguing for a $20 price target for GameStop, said last week he was targeted by a wave of harassment and attempted hacking ahead of a planned video arguing for the short position.

More recently, Melvin Capital Management has seen its value fall 30 percent this month, thanks in no small part to a heavy short position in GameStop. The hedge fund was forced to take a $2.75 billion cash infusion from Citadel to stay solvent in recent days. CNBC reports that Melvin finally closed out its short position Tuesday afternoon, i.e., taking a huge loss rather than redoubling on the short borrowing. But many WSB posters are publicly doubting that report and are confident they can literally bankrupt a massive hedge fund if the GameStop stock price goes high enough.

Is it legal? Is it repeatable?

As the role of WSB in driving up GameStop’s price has become clearer, many are throwing around terms like “stock manipulation” and urging regulator action to look into this kind of ultrarapid stock inflation. Massachusetts Secretary of the Commonwealth William Galvin told Barron’s that he’s “concerned” about GameStop’s stock movement, “because it suggests that there is something systematically wrong with the options trading on this stock.” And the White House confirmed Wednesday afternoon that Treasury Secretary Janet Yellen is “monitoring the situation.”

[Update, 10:25 p.m. ET: The WSB Reddit community went private briefly Wednesday night, and the group’s Discord server was banned from that communication service. See our full report for more details.]

But bringing any sort of legal or regulatory action against a group of Redditors may not be so simple. The legal definition of stock manipulation involves a four-part test that includes actions “specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand.” In a usual pump-and-dump scheme, that means buying a stock and then putting out baseless rumors to encourage others to buy it, driving the price up based on faulty information (i.e., not “legitimate forces”).

For the most part, that’s not what’s happening on WallStreetBets. The opinions on the site are all clearly based on hunches or publicly available information, and they don’t cross the line into misstatements of fact. And there’s nothing illegal about buying a stock just because you think it’s fun or encouraging others to do the same.

“If you can actually catch people knowingly passing on fraudulent information, then that is clearly illegal,” Georgetown Finance Professor James Angel told Bloomberg. “If all they are doing is saying, ‘hey I think this company is a good buy,’ there’s not a lot anybody can do about that.”

This isn’t a hive mind with a clear leader focusing its attention like the Death Star.

So does that mean WallStreetBets just has magical control over the stock market now? Can the subreddit’s millions of members effectively drive up the price of any stock they want just “for the lulz” and rake in the profits?

That’s true in theory. But there’s still a collective-action problem involved in convincing all the WSB players to follow a single lead and work in concert in this way. This isn’t a hive mind with a clear leader focusing its attention like the Death Star. Proposed “bets” that aren’t sufficiently convincing to the throng will either be passively ignored or actively bet against by a segment of the mob, muddying the waters.

The exception to this could be other stocks that are already heavily shorted. WallStreetBets has recently turned its collective attention to stock opportunities like AMC and Bed Bath & Beyond, using the same strategy of buying and holding to force those short sellers to raise the price by covering in the short term. And it seems to be working: Bed Bath & Beyond is up nearly 200 percent since the beginning of the year, while AMC’s stock price has shot up 200 percent today (as of this writing)!