The GameStop Frenzy—Explained

Recently, a stock market anomaly took the internet by storm. Social media could just not
have enough of it, and even Elon Musk was compelled to tweet, ‘GameStonk!!’. For the
uninitiated the rage was simply perplexing, but for the ones who knew what was going on, it
was nothing less than a revolutionary moment. Some have also been as bold to compare the
event to the French Revolution since a notorious bunch of traders on Reddit managed to leave
‘the establishment’ of seasoned hedge fund managers (especially Melvin Capital) seeking
recourse .

It is puzzling to many that this particular surge in the stock price of GameStop proved to be
so intensely damaging to the ‘big boys’ since fluctuations in the market are a common
occurrence. To decode this, let’s decipher a trading practice called ‘shorting’ or ‘going short’.
Say a trader, called Jack, borrows 10 shares worth Rs. 100 of company X from his broker and
sells them immediately. He does this in the hope that the price of these shares will eventually
drop, and he will be able to re-purchase them from the market at a lower cost, say Rs. 85. He
can then pocket the difference as profit, and return the shares to the broker. Jack’s strategy is
what is popularly called ‘shorting’, and as one might guess, people are likely to bet on this
when the chances of the stock-price sinking are high.

Now, GameStop is a retailer of video games, electronics and gaming equipment and the
prospects of such a company in the age of digital distribution seem to be bleak at their very
best. In addition to this, the COVID-19 pandemic and a host of concerningly recent
employee-related controversies didn’t seem to help the stock’s chances either. In fact, at the
beginning of the year GameStop’s stock was trading at $17.25 per share. Reasonably, one can
hardly blame people for wagering against the company in the hope of hefty gains by going
short. So, when the value of GameStop’s shares skyrocketed by over 822% to $159.18
without a clear business reason on January 25 th , many people were caught off guard. This was not only troublesome because it was practically impossible to foresee (by the traditional
methods at least), but also because it had big numbers attached to it. The people who had
hoped for seamless declines, were having to face historic price-rallies. This led to something
called a ‘short-squeeze’. Say the company X Jack had shorted had an unexpected share-value
increase of Rs. 20 placing the stock at Rs. 30. In such a case, he would be making a loss of
Rs. 20 per share if he exited immediately. To avoid even greater losses, Jack and other such
traders would scramble to re-purchase their shares at the earliest. This would ironically drive
the share price even further up feeding into the ‘short-squeeze’.

What makes it even worse for Wall Street is that the drivers of such phenomenon are ordinary
people posting behind funny pseudonyms on Reddit threads. Their coordinated attacks have
left the sour taste of uncertainty in the system. However, some argue that people should have
seen this coming from a mile away as the current conditions make for a more than conducive
climate for such acts. Over lockdown, people’s savings shot up and policy stimulus afforded
them some extra and easy money. To top it all off, the interest rates sunk and accessibility
barriers lowered due to the growing popularity of applications such as Robinhood and
Zerodha. Not surprisingly, studies showed that the infamously rebellious Millennials and Gen
Zs had been trading at a far higher-rate as compared to the broader population. Interestingly,
51% of them also claimed that their risk-tolerance had increased since the outbreak, and that
was evidenced by them parking twice as much money into new trades as compared to the
general investing population. The popularity of unconventional online trading discussions
also surged on social media platforms over last year. Putting all of this together, the GameStop incident seems to be far more explicable. For the far-sighted few, even predictable.

In the whole turmoil, one can’t help but wonder who to pin the blame on. You can’t possibly
fault the Reddit traders as they simply inverted a perfectly legal practice that the elite, suit-
donning Wall Street hedge-fund managers created. In effect, either both are at fault, or
neither and the authority to ascertain that lies with the regulatory body: The U.S. Securities
and Exchange Commission or the SEC. The SEC largely views itself as a law-enforcement
establishment which is meant to penalize ‘rule-breakers’. However, that is not nearly
sufficient and The Wall Street Journal highlights this perfectly in their article on SEC’s
failure:

“It is a role that is as much about setting the right rules and guardrails and culture for the
financial markets than it is about enforcing them. Such a regulator would be constantly
rethinking the role of a public company and public markets and their obligation not just to investors but to other constituencies.”

The Indian equivalent of the SEC is SEBI: The Securities and Exchange Board of India.
Fortunately, SEBI’s thorough and rigorous restrictions make it exponentially harder to
execute the GameStop commotion in India. SEBI doesn’t permit ‘naked short selling’ or
selling shares without owning them in India. It also demands an indication of a short-sale
prior to the transaction, in which case it mandates that all shares be delivered upfront.
Moreover, exchanges also impose circuit filters on stops and restrict their price-swings
between two to twenty per cent. India also doesn’t permit the net position on any stock to
exceed twenty per cent of the free-float, unlike the States where short interest can exceed the
total number of stocks held publicly leading to pressurizing short-squeezes. To put it
succinctly, the SEBI controls the Indian market in such a way where it is dramatically harder
to dodge the norms by availing minor loopholes in the system. It enforces laws not only on
paper, but in their essence and thus a GameStop-like commotion is an unlikely predicament
in India.

This short-squeeze wasn’t the first or the last one the markets are going to witness. However,
the bystanders need to evaluate the need for such financial disarray given the fact that they
are purely based on principles driven by the self-interests of a few. Dialogue around this is
raised every time chaos like this rolls out, but is quickly replaced by the ‘next big thing’ on
the news. It is high time we sustain conversations and witness change, else we should remain
prepared for the worst— and beyond.

Atisha is a second-year student of Economics and Political Science at Ashoka University.

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