David and Goliath Meet Again
GameStop & Fractional Share Trading
It is a time-old adage. The underdog and the giant. David and Goliath. The United States and the Soviet Union in the 1980 Winter Olympics. Erin Brockovich and the Pacific Gas and Electric Company. Fractional Share Traders and Hedge Fund Managers.
GME Short Traders Get Squeezed
Between Monday, January 11, and Wednesday, January 27, 2021, GameStop (GME) stock’s price per share surged an astonishing 1,600%. In the following days, headlines from major television networks to Twitter wars turned to the stock market’s very own saga of the giant versus the underdog — Wall Street versus Main Street.
Before we go to battle, a highlights recap of the market event that now has its own Wikipedia page:
· Mon, 1/11: GME is the most heavily shorted stock on the market. While large shorts from institutional investors and hedge funds is common, the context that the aggregate market short position was greater than 100% of GME shares in circulation is uncommon.
· Tue, 1/12 — Wed, 1/13: GME rises 95% from $20.42 to $39.90, despite a $12.50 median analyst target price. Intraday volatility continues through the week.
· Tue, 1/18: Citron Research, a hedge fund with a significant GME short position, slammed retail investors on Twitter as the “suckers at this poker game” and claimed stock will be “back to $20 fast.” The fund delayed its anticipated stock analysis in the days that followed.
· Fri, 1/22 — Mon, 1/25: GME rises another 80% from $42.59 to $76.79, hitting an intraday high of $158.18.
· Tue, 1/26: GME rises a whopping 92.7% to a $147.98 close. A top Massachusetts regulator reportedly comments that there is some “systemically wrong” with the options trading.
· Wed, 1/27: Melvin Capital and Citron Research close the majority of their GME positions at a loss.
How does shorting work?
Shorting a stock is making a bet that the current share price is not reflective of the company’s true (intrinsic) value. As a trader, you have formed a thesis that a stock is currently overvalued and the time is ripe to open a short interest — that is, you borrow stock from a third party’s reserves and sell it on the market. You make a bet that the price will reduce significantly in, let’s say, three months. You agree to “return” the borrowed stock at this predetermined time by repurchasing it on the market at a lower cost and pocketing the delta.
Shorting: “Let’s say I borrow an Xbox from my friend Nate. Then I go sell the Xbox for… $500 bucks. When the price drops, I buy that Xbox back for $250. I give Nate his Xbox back and pocket the difference.”
Short Squeeze: “When you need your Xbox back but you can’t find a cheap one anywhere and you end up having to buy it back more expensive than you sold it for.”
Jaydan Carr, 10 years old, GME Stock Owner, (ABC News, 2021)
So what is all the GME fuss about?
Imagine now that you are Citron Research and it is time to return your borrowed GME stock. The problem is your investment thesis did not come to fruition — the shares are more valuable than when you originally made your bet. Not only that, but the aggregate market short position is also so great that the influx to repurchase and contractually return borrowed stock intrinsically drives up the stock price even more. In the game of trading, Wall Street calls this market blitz a “short squeeze.”
On the Squeeze: “… but what [hedge funds] didn’t perceive, at a certain point, bears make money, bulls make money, but pigs get slaughtered, and they were pigs.” — Jim Cramer, (ABC News, 2021)
Fractional Shares: Main Street’s Hedge Fund
The newly unleashed power of the retail investor goes hand-in-hand with the 2020 allowance of fractional share trading. A fractional share is just what it sounds — if one unit of stock is $100, a quarter of that share is $25.
Prior to fractional share access, the non-professional, individuals of the retail investor class were largely restricted to trading mutual funds and ETFs. Now, platforms like Robinhood, CashApp, and Fidelity offer the trading and recordkeeping frameworks to support simplified fractional trading for the generalized masses and their varied investment theses.
On Robinhood: “It’s been difficult to get people in the stock market because it’s cumbersome, the rules are hard, and there’s really been no app that just makes it so it’s so easy.” — Jim Cramer, (ABC News, 2021)
Alicia Haverland, Reddit user and Robinhood investor, first purchased GME stock in October 2018 at $14.81 per share. She has been learning day trading essentials since she was a child from her Grandmother, storing keepsakes of advice such as “you can make money and never have to rely on the government or assistance or a man.” As Alicia looked to place her bets, she found herself in an online community of day traders swapping ideas, tips, and analyses, among other content, through a Reddit message board (“subreddit”). She thinks of this subreddit, r/wallstreetbets, as its own hedge fund, managed by the people and for the people:
“We can do exactly what the hedge funders have been doing forever because we are a hedge fund when you really think about it. If everyone has a dollar and there are $6 million of us in here, then we have $6 million. What do we want to put $6 million to?”
Institutional investors and hedge funds, such as Melvin Capital and Citron Research, failed to consider the changing market fundamentals with the arrival of fractional share trading and the collective organization and communication power of retail investors en masse. Their underestimated foe rallied to take advantage with combined motivations of calculated investments theses, protecting a childhood-favorite company, and taking down Wall Street Vampire Squid. As a disclaimer, these motivators should not be considered equal factors in an investment decision, with the last one toeing the line as an illegal market manipulation tactic.
Consequently, the January 2021 GME Short Squeeze becomes a notorious battle of the institutional hedge fund versus the retail hedge fund in the long-waged war between Wall Street and Main Street.
On GME & Robinhood: “The people who started all of this knew what they were doing. To be in a position where you understand the number of short sellers and to be able to convey that to other small investors so that they understand it, it really was a fundamentally driven pursuit.”
— Mark Cuban, (ABC News, 2021)
With the introduction of fractional share trading, retail investors have flooded in with demand, purpose, and collective power. Their demand has shown up in the sheer volume of accounts being created and assets being moved. Their purpose has appeared in their investment theses with their roots spread through traditional (rational) and behavioral economic theory principles. Their collective power has emerged in online communities like Reddit and Twitter.
Originally published March 21, 2021, in partnership with Fagan Associates Inc.
© 2021 Sara J. Wells
References
ABC News (Director). (2021). GameStopped [Motion Picture].
Bogan, D. V. (2019, February). Behavioral Economics vs. Traditional Economics: What is the difference? Retrieved from Hartford Funds: https://www.hartfordfunds.com/investor-insight/behavioral-economics-vs-traditional-economics.html
Reuters. (2021, January 27). Timeline: GameStop’s 1,600% surge in retail investor vs hedge fund battle. Retrieved from Reuters: https://www.reuters.com/article/us-gamestop-hot-timeline/timeline-gamestops-1600-surge-in-retail-investor-vs-hedge-fund-battle-idUSKBN29W237
Yahoo! Finance. (2021, March 18). GameStop Corp (GME). Retrieved from Yahoo! Finance: https://finance.yahoo.com/quote/GME/history?period1=1610323200&period2=1611705600&interval=1d&filter=history&frequency=1d&includeAdjustedClose=true