How GameStop short squeeze roiled Wall Street

Summary

  • The US stock market, beginning January 2021, witnessed a ‘short squeeze’ on select stocks such as GameStop amid a coordinated effort by retail investors on Reddit to keep their prices higher.
  • The ‘squeeze’ refers to the short-sellers’ challenges amid availability of inadequate number of shares for purchase needed to square off their short positions. 
  • Tesla is one such stock which has witnessed ‘short-squeeze’ in the past.

The US stock market, beginning January 2021, witnessed a ‘short squeeze’ on select stocks such as GameStop amid a coordinated effort by retail investors on Reddit to keep their prices higher. Since the stock prices skyrocketed in no time, the short-sellers were caught off guard and were forced to buy in the market and square off their short positions.

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The shares of brick-and-mortar retail firm GameStop rocketed from US$20 as of 12 January 2021 to US$325 by 29 January 2021. How did it happen? To understand the context, we need to first discuss ‘short squeeze’.

What is a short squeeze? 

A short-seller is someone who borrows the shares of a company seen to fall going ahead, to buy them at a lower price later. The difference between the purchase and sale price is the profit for the short-seller. The short-seller makes money in case the share price actually witnesses the anticipated fall and vice-versa. However, a rise in share price, upended by a positive sentiment, could pose challenges to the short-sellers as buyers flock to purchase it. 

The ‘squeeze’ refers to these challenges faced by the short-sellers amid the availability of the inadequate number of shares for purchase needed to square off their short positions. Their fight to purchase only adds to the upward pressure on the share price. Even as the turnaround in the stock price could be temporary, the short-sellers generally avoid risk and sell immediately to save on runaway losses. These challenges can rise manifold if the share price rises steeply in a very short period.

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So, how it started

The ‘short squeeze’ in the US began this January after the major US hedge funds, Melvin Capital and Citron Research, identified GameStop stock as overvalued. However, a group of amateur investors concentrated on a sub-Reddit forum joined hands to quickly purchase it, resulting in a steep upward surge in the Gamestop shares. The group on Reddit, named Wall Street Bets, believed that these major hedge funds were holding over-exposed positions on this stock and hence, wanted to sell. So, these funds were forced into a situation where either they had to continue buying shares at higher prices to cover their positions or sell them to incur potential billions in losses. 

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Short-squeeze on Tesla in the past

Tesla is one such stock which has witnessed ‘short-squeeze’ in the past. While Tesla’s innovative approach towards the production of electric vehicles had many buyers, a good number of short-sellers bet on its failure in early 2020.  There was a time last year when Tesla, with over 18 per cent of its outstanding shares in short positions, was the most-shorted stock on the US share market.

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However, a steep 400 per cent rise in the stock soon after significantly hit short-sellers’ positions, who collectively lost nearly US$8 billion in the late 2019 and early 2020. However, the stock soon fell and the short sellers pocketed nearly US$50 billion in a sell-off over the next few days.

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