At first glance it seemed like child's play, a sure way to make money at the expense of gullible people deluded that they had found "the right title". In reality, thanks to the technology and the abundant liquidity in circulation at almost zero price, it has proved to be an infernal trap with an unexpected outcome: millions of Robin Hoods unleashed on the stock exchanges got the better of the Sheriff of Nottingham. For now at least. But let's proceed in order.
What caused GameStop stock to rise 1.700% in the space of three weeks? Difficult to explain it, according to logic. GameStop is a chain of physical stores that sells new and used video games. In short, something from the old economy with red balance sheets, destined to be swept away by the Internet like Blockbuster. The ideal prey for short sellers, jackals hunt for easy prey. The game consists of borrowing securities to sell them short and then buy them back at a lower price.
But a new fact happened on GameStop (and not only). The stock, the most sold short in 2020 up to 140% of the free float (a share can be shorted several times) has become, thanks to the low face value and the zeroing of commissions by brokers, one of the favorite investments of small speculators who can bet very small amounts and can count on word of mouth on social networks as well as the free time allowed by the restrictions of the lockdown.
A real army that gathers behind the signs of social networks: in particular the Reddit r/wallstreetbets chat room, with 2 million subscribers who go in search of shares unjustly neglected, shares "left behind" that hide real treasures for the tips specialists to be brought to light by shooting arrows in Sherwood forest, or by buying call sharesi.e. contracts which give the right but not the obligation to subscribe for shares at a given strike price and within a certain date.
What happens when so many little Robin Hoods (there are more than two million members on Reddit) buy options whose strike price is much higher than the current quotes, i.e. deep out of the money, and rather short deadlines? The price of options rises if the seller is forced to "hedge" before the contract expires. And that's what happened: GameStop options on Wednesday were lent to meet expiring contracts at a rate of 23,6%, against stock lending interest that typically fluctuates between 1 and 2 percent. You create what is called in jargon short squeeze. I mean, literally, short sellers get squeezed like lemons.
This is what happened to Melvin Capital, a large and respected hedge saved from disaster by the intervention of two big names in the market. But over the past year, the phenomenon has caused short sellers $5 billion in losses. And last Tuesday it was none other than Elon Musk who rejoiced over the defeat of the sellers, who rejoiced in a tweet commenting “Gamestonk!!”.
The phenomenon does not concern only Game Stop. Something like this is happening on Nokia or other fallen nobles, like Blackberry. Without the SEC having so far identified a reason to intervene. In short, it is the market that is taking its revenge for the various tricks to force prices into the tracks desired by the central banks.
“Call options” instead of “call stocks”, to read like that, right?