The GameStop controversy that has dominated the news cycle over the last couple of days has triggered many people to wonder what the fuss is all about. Below is an explanation of the controversy, the terms bandied about when the news reports it, and a chronology of events surrounding the story.
First a brief explanation of some key terms and phrases associated with the story:
“GameStop”: A chain of 5,000 retail stores nationwide, selling and renting video games, which had been looked at as obsolete by Wall Street investors because people play video games online now, rather than buying physical video games to bring home.
“Shorting a stock”: An investor, called a “short seller,” believing the market value of a certain stock is going to plunge, borrows that stock from a lender, sells it to a buyer, then, after the value has dipped, buys it back for less than what he made selling it, thus turning a profit, then returns it to the lender.
“Short squeeze”: A “short seller” discovers he made a mistake— the value of the stock he sold goes up instead of down. This forces him to buy it back as quickly as he can before the value goes higher, often at a loss vis-a-vis what he sold it for, then returns it to the lender.
For example, if John “shorts” a stock borrowed from Bill, sells it to Kevin for $5 a share, and then the value drops to $3 a share, John would buy it back at $3 a share, making a profit, before he returns it to Bill. But if the value rises to $7 a share, John will be forced to buy it back at a loss, and he may have to hurry if the stock continues to rise in value.
“Margin requirement”: the minimum equity (value of the stock held by an investor) an investor must hold in an account after purchasing a stock. Investopedia stated, “It is currently set at 25% of the total value of the securities in a margin account as per Financial Industry Regulatory Authority (FINRA) requirements.”
GameStop started in January valued at $17.25, and had been heavily “shorted,” meaning many Wall Street hedge-fund short-sellers expected the firm to collapse and the value to plunge with it. A Wall Street hedge fund manager, Andrew Left from Citron Research, shorted GameStop, then “held a livestream presentation arguing the stock would fall by 50%,” The Wall Street Journal reported.
But then users of the Reddit group WallStreetBets, led by a financial guru known as “Roaring Kitty” (who had reportedly invested roughly $56,000 to build a stake of 50,000 shares in GameStop), sensing they could execute a “short squeeze” on the Wall Street investors, urged millions of members to buy and hold GameStop stock.
That forced the hedge funds to bid for the shares as quickly as they could before the value soared even further. That buying only fueled the value of the stock to soar further.
In addition, Left reportedly began to get threats, which he reported to the FBI, asking for an investigation. “Mr. Left has also contacted the Federal Bureau of Investigation and the Securities Exchange Commission about the more vicious abuse and what he sees as collusion among the investors,” The Journal noted.
That reportedly prompted the stock to rise even higher, because it looked to the small investors as though they had bested the Wall Street experts.
By Wednesday GameStop’s value had skyrocketed to $347.51.
The small investors who caused the price to soar used free trading apps such as Robinhood to buy the GameStop stock.
“Hedge funds Citron and Melvin Capital said on Wednesday that they had closed out their short positions after suffering undisclosed losses, likely totaling in the billions,” the Daily Mail reported.
The financial apps soon took action. “Robinhood changed margin requirements for GameStop and AMC Entertainment to 100%,” TechCrunch noted. “The short squeeze … also fueled a 2% slide in the benchmark S&P 500 on Wednesday as investors sold other assets to cover their losses,” Reuters reported.
The Daily Mail wrote, “Jacob Frenkel, Securities Enforcement Practice chair for law firm Dickinson Wright, said the SEC would likely look at whether the messaging by investors holding the stock long-term and activists betting against it was manipulative. ‘With federal prosecutors having become much more sophisticated in their cases over the years on securities trading … it is reasonable to believe that any SEC investigation could well have a parallel criminal investigation.’”
Massachusetts state regulator William Galvin urged the New York Stock Exchange to suspend GameStop for 30 days, saying, “This isn’t investing, this is gambling. This is obviously contrived. … It’s diminishing the integrity of the marketplace and it´s putting individual investors at risk.”
Muddy Waters LLC’s Carson Block stated that he thought in time the small investors would regret their actions, saying, “Frenzied retail speculation always leads to tears.”
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