GameStop: It’s all fun and memes until it isn’t. -By Egor Matveev

“So David triumphed over the Philistine with a sling and a stone; without a sword in his hand he struck down the Philistine and killed him.” (Bible Gateway 1 Samuel 17)

The consummate story of David & Goliath has often been used for exploitation and during the recent months, we have seen a new iteration of this myth with Retail & Wall Street. Through the fog of ignorance, misinformation, and conspiracy, I would like, to the best of my ability, to try explain how most claims about the situation, at least during the hype period of January, have been probably fully or partially false while giving a take on the whole situation.

But first, let’s set the stage:

GameStop is a North American brick and mortar video game retailer that has been struggling for the past few years, having not turned an annual profit since 2018.[1] The price of the stock has been on the decline, having gone from 33.8 USD to less than 6 dollars USD between the start of 2015 and September 2019.[2] At around this time, the now famous reddit r/wallstreetbets user Keith Gill, also known by his reddit user u/deepfuckingvalue, began posting about his position on Gamestop (reddit is a hugely popular forum website with r/wallstreetbets being one of its prevalent investment related message boards). He believed that due to the negative opinions about the company being overblown and favorable market conditions (namely the 100%+ short interest), the stock price would rise from 2019 levels.[3] To explain simply, shorting is selling a stock you do not own. The idea is by borrowing stock from someone and selling it at a higher price than when you buy it back, you get to pocket the difference (I borrow stock A and sell at its market price of 10$. The price drops to 5$ and I buy it back to give it back to the person I borrowed it from. I now have 5$). As such, short sellers want the stock’s price to diminish. Now, short interest is a measure of how much of the available stock is sold short. The formula is number of shares sold short/number of shares outstanding. Throughout 2020, Keith’s posts about Gamestop sparked the interest of the subreddit’s users which pushed Gamestop’s popularity in the subreddit. This culminated in January, where many users bought the stock after favorable announcements and provoking tweets from Citron Research, a prominent short seller of Gamestop stock.[4] At this point, the narrative shifted from not only pure personal financial gain, but a desire to ruin the funds that have shorted the stock. At this point, the stock is at about 40 USD and has started to break into the mainstream. What transpired during the last 2 weeks of January was a gigantic rise in volatility, with the stock moving to a maximum of 483 USD, and an internet-wide movement of people buying and holding Gamestop stock to stick it to Wall Street Firms. All over the internet, we saw people exclaiming that they will hold with diamonds hands, that GameStop stock will go to the moon and that this is not about personal gain anymore, but about punishing reprehensible, or even criminal activity. After the weeks of hype, the stock dropped to about 40 USD, a drop of 91% of its value from its maximum but resurged in late February and is now still at an astronomical figure of 181 USD.

Now let’s dive into some of the egregious false claims made by prominent figures online:

It was not David who, with diamond hands, slayed the Goliath.

The initial goal of ruining prominent short sellers such as Citron Research and Melvin Capital was achieved. Namely that on January 27^th, Citron stated that it closed most of its Gamestop position with an alleged 100% loss during the previous week, and that Melvin Capital closed its position on January the 24^thand had to seek financial support from Citadel and Point72 totaling 2.75B USD.[5] Already, the first mischaracterization is the use of term “bail out” and the comparison with the government bailout of big banks in 2008.[6] There is a clear distinction between the government purchasing failed assets from banks and a private entity buying a stake in the investment firm, specifically that Citadel & Point72 gets a stake in Melvin’s profits while the government does not.

But, after doing a little digging, it seems that while the initial rise of GameStop stock came from r/wallstreetbets users, the main hype was not caused by retail investors. To add on, the retail investors have not been able to destroy the funds overall, with many institutional investors reaping huge benefits from this rise.

The first claim rests on data about retail trading volumes released by Citadel Securities, a market making firm [7].

This table details the number of Gamestop shares bought and sold by Citadel Securities on behalf of its retail clients between January 25th and January 28^th. As you can see, barring Monday, retail investors were net sellers of GameStop stock, at least for the volume that went through Citadel (it is reasonable to believe that the volume that went through Citadel is representative of retail investors as it represents a significant market share of the total volume), and as brokers send a lot of retail orders to Citadel.[8] This puts a wrench in the narrative that retailers were buying and holding the stock, forcing short sellers to cover their positions as that would require people to buy the stock without selling it during the rise.

The second claim comes from the fact that a lot of institutional investors have made huge gains of off the Gamestop rise. In fact, at the end of 2020, if you tally up the top 20 holdings of hedge funds (private investment firms that usually are reserved for wealthier people), they owned about 15m shares of the 51m shares in public circulation, or about 30%.[9] If you include the 5 large asset managers (FMR, Blackrock, Vanguard, Morgan Stanley and Dimensional fund advisors), that adds an additional 24.5M [10] (I make a distinction between the two groups as a large part of holdings of large asset managers are often held in funds ultimately sold to retail investors). All these institutional investors saw huge gains as many of them had the ability to sell their GameStop holdings.[11]

On the other hand, retail investors that bought the stock during the week of the January 25^th and that are still holding are probably at a loss (while this is a rough calculation, if you average the closing prices of Gamestop stock between Monday 25^th and Friday 29^th, you get 218.17 USD and the price as of April 1^st was 191.45 USD), although the stock is still completely detached from any reasonable price. At worst, they bought at the highest price of 483 USD and sold before the late February spike at around 40 USD.

Now if the goal was to stick it to rich people & companies, then this was a total failure.

What did Goliath even do?

Many have accused different parties of reprehensible or even criminal activity. Let me go through a few claims that are probably false:

“Hedge funds were naked shorting.”[12]

Naked shorting is when an investor sells shares short without previously borrowing them from someone. This has been illegal in the United States since 2008. Many were claiming that because the short interest was higher than 100%, then there must be naked shorting. This is false and here is an example why:

There is a company with 10 shares (8 are owned by person B and 2 are owned by person E)

Person A borrows 6 shares from person B and sells them short to person C. Then person D borrows 6 shares from C and sells them short to person E. Now at the end, A needs to give back 6 shares to B, B is in possession of 2 shares, C is in possession of 0 shares, D needs to give back 6 shares to C and E is in possession of 8 shares. Even though everyone has borrowed shares before selling short, there is a 120% short interest ((6+6)/10).

To be assured that naked shorting is occurring we would probably have to wait for a statement by the security exchange commission. At this point, they have not found naked shorting in GameStop stock.

“But clearly shorting should be illegal.”[13]

It often feels that short sellers draw undeserved ire from the public. Time and time again, after a prominent short seller reveals his new position, people exclaim that he is attacking the stock. In fact, the hate grows so large at times that it prompts lawmakers to ban the practice, only to reinstall it later realizing their mistakes.[14] Generally, economists and financial market experts consider short selling to be an important part of price discovery as it gives an incentive to investors to look for flaws in a company and signal them to the market through the short sale.[15] In layman’s terms, the market is better when you are both able to bet for and against something. As an example, the fact that Enron was a fraud was initially discovered by Jim Chanos, a fund manager focused on short selling, who shorted the stock in 2000, predicting its collapse in 2001.[16]

“And what about retail brokers disabling the ability to buy GameStop shares. Surely, they were protecting the short sellers.”

A broker is a service that buys and sells stocks for clients. Most retail investors have to go through a broker to purchase or sell stocks. A prominent event that happened on January 28th was the restriction by many retail brokers to buy shares of several pushed stocks, including GameStop.[17] This resulted in rage from the GameStop believers, with most of it aimed on the broker that claims to democratize finances: Robinhood. A lot claimed that the move to restrict buying shares was an attempt to help Citadel, the firm that invested in the short seller Melvin Capital prior to and after the short squeeze, as Citadel is a major client for Robinhood. While this relationship should make you raise your eyebrow, here is why it is implausible that there was collusion between Robinhood and Citadel.

1. If we look closer at this relationship, we can see that the firm that buys order flow from Robinhood is Citadel securities, the market-maker, and the firm who invested into Melvin was Citadel LLC, the hedge fund. While the latter is the owner of the former, there is a legally required firewall between both companies that restricts the flow of information between these two entities.[18] As such, if Citadel LLC wanted to save Melvin by colluding with Robinhood, it would have had to share that information with Citadel securities, which is a major legal risk.

2. Citadel Securities does not want for Robinhood to stop buy orders, because it is a market maker. At its core, a market maker is an entity that matches buy and sell orders and profits from the difference between each buy and sell order. As such, generally benefits from higher volumes of stock trades. For that reason, they have doubled their revenue in 2020.[19] Now, what did we see in GameStop stock? Unprecedented amounts of stock being traded, with a huge amount of retail investors buying and selling the stock. Asking Robinhood to stop people from buying equates to refusing to make money.

3. A way more plausible explanation has been put forward by the retail brokers, including Robinhood, but it requires to explain how order processing works. When you ask to buy/sell anything in your brokerage account and your order gets processed, you do not actually have possession of the shares yet, you merely have your order registered. In fact, you only gain possession of your shares after 2 business days and after all the orders are cleared (the process of tallying up every order to see who owns the shares in the end and who needs to pay whom) and settled (the process of exchanging money and assets). In the US, this whole process is done between the Depository Trust & Clearing Corp, a private firm who does the clearing and the settling, and the brokers who act on behalf of their clients giving and receiving assets and money from and to the DTCC (in Canada we have a similar system with Clearing and Depository Services being the equivalent of the DTCC). Because of the 2-business day delay, the DTCC requires brokers to put up collateral (an amount money) in case they need it to buy assets. On the other hand, monetary collateral is not required for selling assets, as brokers receive money in that case. Now, during the frenzy, the DTCC demanded large sums of collateral from brokers to ensure settlement could happen even with the astronomical volumes and volatility of stock like GameStop. In fact, on January 28^th, Robinhood had to provide 3 billion USD in collateral immediately, a very big amount even for a company of this size. To be able to fund this, Robinhood raised money from all its credit lines and had to raise money from investors. Even after all the fundraising, it was only able to raise 1.4 B USD. As such, Robinhood proposed that to reduce its settlement risk, the unraised collateral would be compensated by a restriction on the purchase of its most traded stocks, which of course included GME.[20] I remind you that the more people buy Gamestop stock, the bigger the collateral requirement becomes, while sales help reduce the amount of money Robinhood needs to provide during settlement. This is why Robinhood allowed selling and restricted buying.

There is a possibility of collusion, but without hard evidence to support it, it is unlikely. On the other hand, the story of collateral requirements adds up with the actions of the parties involved.

What now?

In the end, this whole situation has me frustrated and disappointed. On one end, we have influencers like H3H3 productions [21], online “financial education” channels like the Stock Guy [22], politicians like AOC [23] and Ted Cruz [24], and supposedly smart people like Elon Musk [25] and Mark Cuban [26] buying into the hype and spreading misinformation. On the other, we have the masses liking, retweeting, commenting, upvoting and buying GameStop, gobbling up and promoting these false narratives. After these events, I find it incredibly ironic that people demand for better media but go on to believe this crap. We live in an age of misinformation and it seems it is our irresponsible behaviour that contributes to its continuation.

I do not like Robinhood. I find that their platform transforms something that should be taken with seriousness into a game you would find at the casino. I would only recommend it to those who want a new place to gamble.

I do not take what people at r/wallstreetbets say seriously. While there are a few gems like Keith, who actually find overlooked and unorthodox opportunities in the market, the vast majority of people gamble their life money at hyped stocks without an ounce of reason. A key feature of that community is loss porn, or posts showing accounts that have lost tens, hundreds, and even millions of dollars. Oh by the way , this subreddit has 9.7 million followers, about 6 times as much as r/investing, a subreddit with advice that has a way lower likelihood of wiping your entire savings in a few months. Do not take any advice from r/wallstreetbets or anything that originates from it.

I acknowledge the existence of corporate fraud and in fact, I would like to tell you that Citadel has had a troubling regulatory history, being fined on multiple occasions. It is alarming to know that companies can own an investing business and a market making business, and I would love to see lawmakers looking into this relationship and strengthening and funding the enforcement of the law where need be.

But no one who promoted the GameStop hype helped any of these issues to get solved, rather they muddied the waters between actual problems and conspiracies spread by the internet.

The stock is still hyper volatile. There are talks about a gamma-squeeze and people at wallstreetbets are still buying and holding with their diamond hands. I just hope that after reading this article, you understand that you need to learn about financial markets and do your due diligence before deciding if you want to join in.

- Egor Matveev (IB Economics)

P.S. If you are interested in learning about everything related to finance, a very good source in my opinion is https://www.investopedia.com/. It is basically an advanced financial wikipedia that answers most questions related to finance.

[1] https://www.macrotrends.net/stocks/charts/GME/gamestop/eps-earnings-per-share-diluted

[2] https://imgur.com/AFTg3rj

[3] https://www.youtube.com/watch?v=GZTr1-Gp74U

[4] https://abcnews.go.com/Business/gamestop-timeline-closer-saga-upended-wall-street/story?id=75617315#:~:text=The%20now%2Dlegendary%20r%2Fwallstreetbets,with%20one%20of%20the%20founders

[5] https://www.cbc.ca/news/business/gamestop-wednesday-1.5889652

[6] https://imgur.com/wIrkAoY

[7] https://www.bloomberg.com/opinion/articles/2021-01-29/reddit-traders-on-robinhood-are-on-both-sides-of-gamestop

[8] https://www.washingtonpost.com/business/2021/01/29/robinhood-citadel-gamestop-reddit/

[9] https://hedgefollow.com/stocks/GME

[10] https://www.nasdaq.com/market-activity/stocks/gme/institutional-holdings

[11] https://www.washingtonpost.com/business/2021/02/08/gamestop-wallstreet-wealth/

[12] https://www.reddit.com/r/wallstreetbets/comments/l62h7w/naked_illegal_short_on_gme