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The big GameStop short: Reddit traders confound hedge funds

January 28, 2021

Established US investment funds Melvin Capital and Citron Research bet that stock prices of an aging video game high-street retailer would keep falling. But Reddit users teamed up to confound their short positions.

GameStop Shop
The ageing bricks-and-mortar video game store is at the center of a fight between amateur traders and professionals on Wall StreetImage: STRF/STAR MAX/IPx/picture alliance

The tables turned on Wall Street as Reddit traders continued to push up stock prices from the aging US video games high street store chain GameStop on Wednesday.

Established US investment funds Melvin Capital and Citron Research had placed bets for money-losing GameStop's stock to continue to fall.

Amid the advent of online gaming platforms like Steam and the trend of people buying and downloading their new video games directly, rather than buying a physical copy in a store, few stock market bets appeared to be safer.

But, despite no real change in the company's precarious position, GameStop shares have been on a meteoric climb from just $18 (around €15) a few weeks ago to a high of $380 on Wednesday. 

This has been driven by large numbers of non-professional traders, known as retail investors, supporting each other on Reddit threads such as r/wallstreetbets.

How much money did the funds lose?

Citron Research acknowledged Wednesday in a YouTube video that it unwound the majority of its bets against GameStop's share price, taking "a loss, 100%" to do so.

Melvin Capital is also pulling its resources from short positions on GameStop shares, with manager Gabe Plotkin telling US broadcaster CNBC that the hedge fund was taking a significant loss. He rejected rumors that the backfired trades posed an existential threat to the fund.

Melvin Capital accepted some $2.75 billion (€2.27 billion) in investments from two other groups, in what was seen as an emergency influx of rescue capital.

The exact size of the losses taken by Citron and Melvin are unknown.

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How Reddit users caused the huge losses:

Gamestop's stock had been falling for six straight years. Many professional investors had bet that this decline would continue.

In such bets, called "short sales," investors borrow a share and sell it. They are then obliged to buy back the borrowed share at a later date. The bet pays off if the price drops in the interim period, meaning the traders can pocket the difference.

Both Melvin and Citron placed such bets, heavily. GameStop was one of the most shorted stocks on Wall Street.

When users of the Reddit threads like r/wallstreetbets realized this, they saw a way to profit at the pros' expense. By joining forces to buy up GameStop stock, they were able to ruin the short positions held by the hedge funds.

This in turn forced hedge funds to cut their losses post-haste, liquidating their contracts by buying back shares they owed in the company and selling them one last time. Done en masse, this sent the already-overvalued stock prices soaring higher still, ready for the amateurs to sell their papers and cash in.

Will this last?

Much of professional Wall Street does not think that GameStop's stock can hold onto its gains, to put it mildly.

The company fundamentals are in no way impacted by this stock market chicanery, analysts say. This most unusual bubble was already showing signs of having burst by the end of trade on Wednesday, with GameStop shares back down to $347.51.

Analysts at BofA Global Research raised their price target for GameStop on Wednesday from $1.60, all the way up to $10.

Some smaller investors online are already moving on to other heavily shorted stocks as their next targets.

AMC Entertainment Holdings Inc., a US theater chain hit hard by the coronavirus pandemic, saw its stock surge 301% Wednesday, and #SaveAMC was trending on Twitter.

The White House and Treasury Department are monitoring the situation involving GameStop and other companies that have seen sharp gains on the stock market, White House Press Secretary Jen Psaki said on Wednesday.

kmm/msh (Reuters, dpa, AFP)