gamestop stock hedge fund

Game Stop, Arthur Square, Belfast, Northern Ireland. Photo: Wikimedia Commons/Ardfern

GameStop stock saga explained: The long and ‘short’ of how Reddit users annihilated Wall Street pros

The GameStop stock debacle is so very, very delicious. Here’s what you need to know.

gamestop stock hedge fund

Game Stop, Arthur Square, Belfast, Northern Ireland. Photo: Wikimedia Commons/Ardfern

You may have noticed GameStop dominating the interwebs this week. What you may not know is that the GameStop stock saga is actually a pretty big deal; a watershed moment played out between home traders on Reddit and hedge fund pros from Wall Street.

Before we can dig into this delicious debacle, you need to understand what a “short” is.

GameStop stock surge saga explained

But first: What is a ‘short?’

A short is when you borrow stock from a broker without actually owning it or paying for it.

To make this easy, let’s say the stock costs R10. You’re just borrowing it, so you didn’t pay R10. You then sell it immediately for the same amount, betting that you would be able to buy it back for less, later.

Let’s say in a week’s time, the stock is worth less than R10. It’s now worth R1 and you decide to buy it back. Remember that you “borrowed” it in the first place. You didn’t spend R10 on it but sold it for R10, and are now buying it back for R1, making R9 profit. Let’s repeat: You made this profit without spending a cent on it in the first place (other than the fees involved).

This is legal; there is no law which says people can’t buy stock and short it. Redditors have now, however, also shown that this is a proven way to stick it to Wall Street players and make a profit off of nothing.

So, what happened with GameStop?

Good question. GameStop went through dark times in 2020, teetering on the verge of going out of business due to the COVID-19 pandemic. At some point last year, the stock price plummeted and investors began buying stock.

Then, hedge funds showed up and began “shorting” the stock, hoping to buy it back later, for much cheaper. Home traders on Reddit – specifically from the WallStreetBets subreddit– saw the influx of people buying GameStop stock.

Some Redditors decided to buy stock and convinced their buddies to do the same. At this point, I should add that WallStreetBets had recently ballooned to over 3 million followers. As they motivated each other to keep piling into the shares, the stock price went up again, leaving hedge funds who took short positions liable for the current inflated stock price.

Thanks to thousands of Redditors, GameStop stock didn’t plummet as the hedge funds had hoped. To keep with our example of earlier, this is what happened: Instead of the R10 stock plummeting, it skyrocketed. It wasn’t worth R1, as the hedge funds had hoped; it wasn’t even worth R10. No, it was now in the region of R500.

GameStop stock prices

That R500 I mentioned is just an example, we’ll get to the actual prices now.

Instead of making a profit, the hedge fund losses surpassed $13 billion (yep, that’s a 13 with nine zeros, or roughly R196 billion rand). This time last year, GameStop stock was worth approximately $4 (around R60).

By October 2020 it was $11 before increasing to $40 at the start of 2021. At the time of publishing – and at its highest point today – GameStop stock was worth $370 (R5 600).

This led to the hedge funds having to close their short positions and buy the stock back at much higher prices. Remember they borrowed it in the first place, it was never really theirs, and as with all Lannisters, they were forced to pay their debts.

Is it illegal?

The irony here is that buying the stock back at higher prices sent the stock price skyrocketing even further. This is also known as a “short squeeze”. The result? The hedge funds – or one in particularlar, Melvin Capital – are now expected to declare bankruptcy.

This is why Wall Street pros are claiming what happened with GameStop should be declared illegal. But it isn’t illegal, and it never was. The hedge funds were just beaten by their own game, and spectacularly so.

And that’s the long and the short of it.