By Toviya Slager, Staff Writer
The headlines in January 2021 were flooded with stories of GameStop (GME) stock soaring from $20 to $350, and then back down to below $50. Many in different fields seemed involved one way or another: Wall Street was being “” from their position, Robinhood stopped the ability to buy, and a man going by the name of ‘Roaring Kitty’ (or Keith Gill in real life) became the hallmark for financial advice due to his YouTube videos which became famous for promoting buying GameStop. After almost a year of analysis, the Securities and Exchange Commission (SEC) finally published a report on the true events that unfolded this past winter. The conclusion: it was just crazy investors.
The behind buying shares of GameStop (GME) stock was that the stock had a short interest over 100%. This meant that the stock had been borrowed more times than actual stock existed, also known as naked shorting. The theory was that if individual retailers banded together and pushed the price higher, it would force the short-sellers to cover their position and fight over the outstanding shares which would then push the shares even higher, known as a “short-squeeze.” GameStop’s short interest was already mentioned on Reddit in 2019 and received more attention throughout 2020. By January 2021 the short interest reached 123%, which was far larger than any other stock, and the only one above 100%.
In the report, the SEC believes that there was no naked shorting involved with GameStop and the percentage just reflected stock being lent multiple times. Naked shorting is considered an illegal activity, but lending a stock a few times is not, even though it looks the same in the short-interest percentage. There were a few funds that lost considerably by the time they covered their short position, but broadly, the SEC says that hedge funds and institutions were largely unaffected. Melvin Capital Management lost 53%, and is one of the few funds that lost heavily during the event. Both Citadel and Point72 gave almost $3 billion to Melvin to shore up its finances. There were actually several funds who joined the rally and profited from the volatile situation. Senvest Management, for example, made $700 million! While there are a few small spikes that can be correlated with short-covering, this volume represents only a small fraction of the total traded volume, which means that the large price rally was not really affected by short-covering (Chart A).
The second theory centered around an event called a “gamma squeeze” Gamma is the element of an option price that reflects the movement of the underlying stock. When an order is put into the market, there is not always a person available to take the other side of the deal. Market makers usually will take the other side in order to make sure markets run efficiently, while receiving the difference between the buying and selling price when they sell their position to a buyer when they show up. Market makers, however, sometimes keep positions in their books for a while and in order to prevent loss due to unexpected volatility, they will attempt to hedge their position by buying the underlying stock in the event they need to deliver on the options they created. In other words, they will buy the stock in advance so that if the stock price passes the exercise price, they will not lose when they need to deliver the stock. When many people bought GameStop long-options, it created a large short-position with the market makers. To prevent large potential losses, the market makers bought GameStop to hedge their position, which further pushed up the stock price.
The SEC, again, found that this was an unlikely cause. Normally gamma squeezes occur when there is a large increase in purchases of call options where the market makers buy the underlying asset to hedge their position. While the number of options traded increased from $58.5 million on January 21, 2021 to $2.8 billion on January 27, 2021, the vast majority were traders buying put options rather than call options!
In that case, what caused the spike? The SEC concluded that GME experienced a confluence of five factors: large price moves, large volume changes, large short-interest, frequent Reddit mentions, and significant coverage in mainstream media. In another word, hype. People traded because the price was rising and wanted to join the party. Only a few months before the pandemic began, Robinhood became famous for free trading (lack of trading fees) and many other brokerages followed. Some even started offering a free share of stock for opening an account. According to the SEC report, the average age of a Robinhood account is 31 years old and maintains a balance of $240. In 2020 approximately 6 million accounts were opened, which is a 137% increase from 2019. Of those 6 million accounts, about 1 million are investors with an average age of 19 years old. The number of individual accounts trading GameStop increased from 10,000 at the start of January to 900,000 at the peak (90x). The number of institutional accounts trading GameStop was dwarfed by the individual investor (Chart B).
The GameStop episode shows the power of the group. It may have seemed impossible in January for individual investors to have the ability to drive a stock price up 2,700%, but the SEC concluded that with strong collaboration through Reddit and social media, the price moves were mainly pushed by these individuals. This entire story introduces a major question: What other unexpected accomplishments can we accomplish through mass collaboration?