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Jan 27, 2021 · The reason is two-fold, both of which are far removed from anything related to the company’s fundamental strength: Investors following the Reddit group bought a …
What is Gamestop surge?
On its face, the GameStop surge appears to be a classic pump-and-dump scheme, in which a group of people collude to hype up a stock, artificially increase its share price and then sell at a profit.
What is the problem with Melvin?
The real problem for Melvin is that it was also shorting GameStop, meaning it was borrowing shares of GameStop, selling them on the market and using those proceeds to make other investments. Problem is, Melvin eventually has to return those GameStop shares.
Who is John McDermott?
John McDermott John McDermott is a writer whose work has appeared in Chicago Tribune, Vice, The Atlantic, Fast Company and MEL, among other publications. This content is created and maintained by a third party, and imported onto this page to help users provide their email addresses.
What is call option?
A call option is a contract that gives the owner the right, but not the obligation, to buy a stock at a future date, at a predetermined price. (Options are popular because you’re not left holding the bag if the market goes against you.)
The internet phenomenon behind the rise
Individual investors using the online message board Reddit to egg each other on appear to be behind the stunning increase in value.
The big squeeze
The other effect of retail investors pouring into the stock is that short-sellers are being “squeezed”.
Revenge of the little fish
Melvin Capital is a hedge fund (worth $12.5 billion until recently) with a “short position” on GameStop. A short position means Melvin was betting GameStop’s share price would fall (a reasonable bet, as the outlook for brick-and-mortar video game stores is a bit like what happened to Blockbuster and other video rental outlets).
How long can Redditors remain irrational?
How is it possible that small retail investors can drive the value of a company up like this?
How buying creates more buying
This leads to the second factor, which is mechanical. The retail investors driving the price surge are much smaller than the hedge funds they are battling. By buying the stock and call options (which are effectively rights to buy the stock in future at a certain price), retail investors are causing market makers to also buy shares in GameStop.
After the surge
These two factors – short-sellers getting squeezed and market makers hedging their bets – have led to this situation. You need both for what we are witnessing: an investor with an exposed position (Melvin) and a flurry of investors targeting that position (Redditors and others).
