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BIG SHORTS SCORED BIG LOSSES

By Aanchal Shah

Despite Melvin Capital Management LP being an investment management firm, they recently lost major 53% in January, hurt by GameStop and other bets. It’s very uncommon and hard to believe that a regular brick and mortar video game selling store can have its share soar up to a ridiculous height amid the destructive pandemic. Unsurprisingly, when the pandemic hit, the store had its fair share of bad months, and its revenue fell hard due to its physical retail presence. 

But what made this regular store a big story? What led its share price rise from $4 in September 2020 to a marvelous $347.51 by January? How were predictions by intellectual investors proven wrong? 

One Word: Manipulation. 

In recent years, streaming and purchasing video games online has gained fashion. Therefore, for a physical retail store like GameStop, there was an urgent need to shift their traditional business model. Back in August 2020, Ryan Cohen (Founder, Chewy), Alan Atal (Previous COO and CMO, Chewy) and Jim Grube (Previous CFO, Chewy) started to buy shares of GameStop in huge numbers. By December 2020, Cohen’s invest firm “RC Ventures” had built up to a 13% stake in GameStop. Since Ryan and his partners had experience in running an e-commerce company, they were appointed to the Board of GameStop. 

          Source: Grossmont Center

Coming to GameStop’s rise, it was initially due to regular market fluctuations. The release of PS5 and the X-Box series marked the beginning of a new console cycle for the store. Adding to the good news, the store had also signed a deal with Microsoft, which gave them a share of all the X-Box’s digital revenues. Both these reasons saw fluctuations in the share price. 

But what caused the stocks to soar ridiculously high? 

Some sources believe that it was “Mental Reddit Investors” that ruined the market. And others believe the Hegde Funds to be more manipulative than the internet forum. 

In order to know where things got crazier, there are three important terminologies to understand: 

1. Short Stocks: When investors believe that a company is going to do badly or it is going to collapse; they desperately “short positions”. This means that unlike regular trading, they “sell” the stock first. In the coming future, when the company falls in revenue generation and their share price reduces further, the investors square off their positions by purchasing the same amount of shares. This helps the investors to make profit even when the market falls down. But there is something more to it. The short interest can be greater than one hundred percent of the actual available stocks. It depends on the nature of the short sale transaction itself. 

(II) Melvin Capital Management LP: It is an American investment management firm founded in 2014 by Gabriel Plotkin, which is based in New York City. It invests primarily in tech and consumer stocks and is reported to have $8 billion in assets under management as of January 2021.

(III) WallStreetBets: Also known as WSB; it is a subreddit where participants discuss stock and option trading. 

                                Source: TDLR News, US

Coming back to the stocks, Andrew Left (Citron Research and Melvin capital) had claimed that GameStop stock prices will collapse; therefore they shorted positions. Believing that the share prices would go even lower, the institute actively shorted more to suppress the stock price. 

About 20% of GameStop shares are held by the insiders of the company. The insiders cannot easily sell their shares due to insider regulations. Hence, out of the total 69.5 million shares, only 55 million shares are actively traded stocks. 

According to sources, Melvin Capital had a massive 4 million short positions in the GameStop stocks as of January 1, 2021, despite the fact that that was the day when the board was announced. In order to gain more profits, Melvin Capital aggressively shorted positions until it reached a total of 71 million shorted positions. The fact of the matter is that GameStop has a flow of only 69.5 million shares! Remember, there can be more short positions than actual shares. 

This news was public and without giving a second thought, the WallStreetBets chalked a plan to gain huge from this opportunity. WSB was adamant that if they bought the stocks and held it, they could force the prices to soar high. Taking advantage of the “Huge demand and Limited Supply” phase, WSB started buying shares of GameStop. By the end of 2020, they had bought a lot of shares and the prices were seen skyrocketing. It got worldwide attention in too little time and caused a frenzy among the buyers. It got famous among the investors to earn big in little time. From $5 per share in September 2020, it had reached to $20 per share in December 2020, and even higher in mid Jan 2021 to $40 per share. But the Melvin capital was still determined that the GameStop stocks will collapse. Meanwhile, Elon Musk’s tweet “Gamestonk” extended this Reddit-driven hyper rally. 

                        Source: Twitter 

By this time, Melvin capital felt the need to square off their positions by buying the shares even at such a high price to prevent much bigger losses. But the WSB did not sell their shares; which took the stock price even higher up to a ridiculous $347.51 by the end of January. 

Some sources believe that it was the Melvin’s aggressive investing strategy that manipulated the market, and that the internet forum had less action in the game. But sure, it was in fact the stocks we undervalued and over shorted to end with.