GameStop Scandal Explained: Understand everything about the Controversy

GameStop Scandal Explained: Understand everything about the Controversy

The game store chain GameStop is shaking global finance due to a big Stock Scandal. On Friday, Jan 22, the stock of the GameStop group, owner of stores of the same name in the United States and Canada, and of Micromania-Zing in France, skyrocketed by 50%. The following Monday, January 25, the stock climbed another 18%. On Tuesday, January 26, the increase was 93%, while on Wednesday, the stock had a variation of + 135%! But what is happening in the financial markets? We come back to the GameStop Scandal Controversy which still shakes the world of finance today.

The mechanics of “short selling

With the 2020 lockdown, the number of young and amateur traders has skyrocketed around the world. These new investors obviously behave very differently from traditional stock marketers. The idea behind what happens to the GameStop title is to play with the system by using its mechanics. On the stock market, the most classic strategy is to buy stocks at a given price one day, then try to sell them later when they reach a higher amount. This is called making a capital gain, a capital gain made possible by a gain in the value of the company which has opened new stores, launched new products, or even improved its performance and profits by reducing its operation costs.

What is less known to the general public is that it is possible to do exactly the opposite, namely bet against a company by believing that it will decline, announce bad news, be confronted with difficult situations. In other words: losing value on the stock market. This is called short selling, or “short selling.

The mechanics may seem ubiquitous: instead of buying a stock from someone and keeping it with a view to reselling it at a higher price, you have to do the exact opposite. The idea is not to buy but to sell the stock which is estimated to be overpriced, with the strategy of buying it back later when it is cheaper. In order to sell a stock that we don’t own originally, we first have to borrow it from someone, in exchange for the cost of renting the stock.

Let us take a practical case. Say on March 1, you borrow a stock worth $ 100 from an investor with the goal of selling it. You promise him that you will return a copy of this action to him by March 31 at the latest, all accompanied by a rental fee for the action, say 1 euro. The investor who lends is very careful, he seeks to make his actions work for the long term, not to buy or sell fluctuations. What matters is that he finds the same number of shares at the end, he is just looking to earn on the rental fees he charges. Luckily, you were right, the company announced poor results on March 12, its stock price fell to 80 euros. From this point on, you can complete the transaction by buying it back for 80 euros on the financial markets and returning it to the borrower, with the rental fee (1 euro in our story). You made a profit of 19 euros. But you can also be greedy if you are convinced that the stock will continue to collapse, because a new containment will paralyze the economy, because you are convinced that losses in the accounts of the company have been hidden, and that it can go down even lower, until bankruptcy. If the company closes, it’s the jackpot, since you don’t have to return the share of a company that no longer exists. It is enough just to continue to pay the rental fees every month to the lessor, who can extend the rental contract as long as he does not absolutely want to find his original action.

Honor the contract

It is in this kind of daring bets that some investment funds have specialized in seeking to generate profits by betting against companies in poor health. And it is this mechanism which was used against GameStop… and which is at the origin of its success. Let’s take our example of a stock sold short for 100 euros, but this time, it announces very good news, profits instead of losses for example, and there its price takes off. The share then rises to 300. However, it will be necessary to buy back a share at some point to honor the rental contract and return it to its original owner. 300 – 100 = 200 euros loss, plus rental costs. This is just one example, but in reality this mechanic can be used by millions of people for amounts amounting to millions of dollars. With in addition the typical phenomenon of finance and the disconnection with reality that it can cause: A has sold short a share to B, who leases it to C, who sells it short to D , who himself leases it to E who sells it short. While there is only one share in circulation, in theory, we end up with 3 people, A, C, and E, who have to “redeem” it. What happens if everyone has to pay off at the same time, or suddenly no one wants to lease the share? The market is racing, and prices are soaring because everyone tries as quickly as possible to find an action to get out of the situation. This is what happened with the GameStop action.

The slingshot organized on Reddit

Struggling for years, GameStop had a series of losses after losses and store closings. At the start of 2020, the group was worth only $ 253 million. For the vulture funds, the deal was done: GameStop was heading for bankruptcy, and several of them had opened significant short positions betting on bankruptcy. But that was without counting on the community of about a million atypical investors of Reddit WallStreetBets. This community of young traders wanted “support” GameStop. Their motivations are varied: attachment to a brand that accompanied their childhood and adolescence, conviction that the chain of stores is worth more than 200 million capitalization … and above all a desire to show the older generation of finance that the strength of a community, even linked only by Internet, can change everything.

Throughout the summer, the WallStreetBets community was strongly encouraged to buy GameStop shares. In the spring, the action was worth $ 4. At the end of the summer, the stock was worth $ 7. End of September, 10 dollars. In November, 12 dollars. In December, $ 15. A rise supported by the forum in which the investment funds going against GameStop did not believe. The latter effectively continued to sell stocks short, believing strongly in the bankruptcy of GameStop and believing that they could reverse the buying trend on the downside. Wasted effort : the community continued to grow, to buy GameStop shares, until a turning point took place. Mid-January, GameStop announced that it had had a good quarter thanks to the release of the PS5 and Xbox Series, and appointed new administrators. The good prospects for the company are finally coming! This is where the machine races. The conviction of the forum finally finds an echo in reality with these good results and the action is skyrocketing. Hedge funds continue their bet against GameStop, the value of the US stock exchange against which there are the most short positions, but users of the forum understand what is looming: a “short squeeze”, The situation mentioned above, where short sellers will have to chase after the shares they have to redeem. The forum sends the message that it is necessary to keep and not to sell.

GameStop’s course holds, then flies away and is worth 20 times more than on January 1. Some forumers claim to have earned enough to repay their student loans and to be able to change their lives. The investment fund that was banking on GameStop bankruptcy, Melvin Capital, is losing nearly $ 3.5 billion to get out of its short position. Some trading companies go so far as to suspend the possibility of buying the GameStop share (without suspending the possibility of selling it …), whereas they are supposed to be neutral vis-à-vis the market. The boss of the American stock market announces that he is closely monitoring the affair, as does the team of Joe Biden, the new president of the United States. And to think that analysts repeat that the financial markets are supposed to self-regulate …

While price manipulation has always been illegal, “stock market buzz” are not new, but they now take place on social media, not at investor fairs or in financial magazines. This is a big game-changer. The story of GameStop will go down in the economic history books as what appears to be the first victory for young investors and gamers against the world of the stock market in suit and tie. A situation applauded and encouraged by Elon Musk himself, founder of Tesla who similarly lifted and returned shorters in 2020. Today, the purchase of GameStop shares has been suspended on several platforms. As a result, the price ended in the red but it recovered after the session. We have noted political reactions around the affair. For the first time, a Republican Democratic front appears to unite to seize the controversy. He is particularly interested in the investment fund Citadel which is involved both as a financial intermediary for Robinhood and which is also a shareholder of a fund which had “shorted” GameStop. What is certain is that the business continues to rebound and goes beyond the scope of video games today.

Samuel Edwards
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