Practical analysis for investment professionals
31 January 2021

GameStop or: Why the Short Sellers Win

By now, another GameStop-related opinion piece about how retail traders ruined short sellers and cost hedge funds a reported $23.6 billion is probably the last thing you want to read. Don’t worry, this op-ed is a bit different, because I think the short sellers have won and the retail traders lost.

Let me explain why.

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Everyone knows the story. GameStop was in trouble for a long time and thus a prime target for hedge funds selling shares short in hopes of profiting off the company’s demise. Then, retail traders on the subreddit WallStreetBets talked about how they made money betting on GameStop and an avalanche of small trades came in. On platforms like Robinhood, retail traders pushed the stock ever higher, creating a frenzy that caused both a short squeeze and a gamma squeeze in the options market. Now the retail traders who went into GameStop are celebrating their victory. The stock has risen 1,642% in 2021.

There is just one problem.

A successful trade consists of two actions. First, you have to buy a stock that then increases in price. Then you have to sell that stock at a profit and lock in those gains. The beauty of investing is that it is a race that has no finish line. There is no point at which everyone can assess their profits and losses and compare themselves to others. Markets go on all the time and while you might be ahead one day, you can easily lose everything the next.

This is a particularly important lesson to heed in a bubble. There is no doubt that GameStop is in one right now. But there are so many different ways to define bubbles. Maureen O’Hara, the 2020 winner of the CFA Institute Research Foundation’s Vertin Award, provided an insightful analysis of the various meanings in a recent Washington Post column.

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To me, a bubble’s most interesting phenomenon is what John Kenneth Galbraith called “the bezzle,” or the “period when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.” We are in the GameStop bezzle now: The short sellers have already won, but the retail traders feel no loss.

Without a doubt, the hedge funds that had short positions in GameStop lost a lot of money. But there’s an interesting observation embedded in the trading volume of GameStop shares. Towards the end of last week, it plunged by about two thirds between 26 and 27 January. Then, when Robinhood and other platforms briefly blocked traders from buying GameStop, the stock fell more than 60% before it started to recover. In that time frame, trading volume also dropped significantly.

This is no proof, but it indicates that the short squeeze is over. By now, GameStop shares are entirely the domain of traders and speculators. No short seller or any self-respecting institutional investors is still in the stock. We have entered the phase of the bubble when traders can only make money if they find a greater fool who is willing to buy the shares they are trying to sell in hopes of finding an even greater fool to sell the shares to later.

Forgive the pun, but at some point, this GameStop greater fool game will stop. Every bubble in history eventually comes to a point when there just isn’t enough fresh money flowing in to sustain it. And no social media hype can stop that.

I started my career as an investor during the tech bubble of the late 1990s. Back then, Reddit didn’t exist, so people hyped stocks on Yahoo! Finance boards and other platforms. The mechanism was the same, even if a smaller number of people had access to the internet and so the bubbles were smaller too. We know how that story ended. And we know that it wasn’t the short sellers who lost their money. In the end, the losers were the last fools in line, those who owned bubble stocks with no greater fool to sell them to.

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If you own GameStop shares today, you’ve already lost most of your money, you just don’t know it yet. The short sellers have left the market. But don’t for a minute think they are licking their wounds in defeat. They are regrouping and likely already circling GameStock again, waiting for the right time to sell it short at a much, much higher price than their original short. And when the bubble pops, they will make billions in profits while retail traders will lose billions.

The irony of it all is that to sell GameStop shares short, these traders will have to borrow them from their current owners. And many retail traders don’t know that they have signed terms and conditions with their custodians that allow them to lend the securities in their portfolios to other investors for a fee, none of which ends up in the traders’ accounts, of course. So these traders are going to lend their shares to the very people who will eventually bankrupt them.

For more from Joachim Klement, CFA, don’t miss Geo-Economics:  The Interplay between Geopolitics, Economics, and Investments7 Mistakes Every Investor Makes (And How to Avoid Them), and Risk Profiling and Tolerance, and sign up for his Klement on Investing commentary.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: Cropped image, courtesy of Keith C. License.

About the Author(s)
Joachim Klement, CFA

Joachim Klement, CFA, offers regular commentary at Klement on Investing. Previously, he was CIO at Wellershoff & Partners Ltd., and before that, head of the UBS Wealth Management Strategic Research team and head of equity strategy for UBS Wealth Management. Klement studied mathematics and physics at the Swiss Federal Institute of Technology (ETH), Zurich, Switzerland, and Madrid, Spain, and graduated with a master’s degree in mathematics. In addition, he holds a master’s degree in economics and finance.

13 thoughts on “GameStop or: Why the Short Sellers Win”

  1. Ajh says:

    Hmmmm. Many credible sources say short interest remains very high. Michael Mackenzie in the FT this weekend quoted Morningstar that short interest in GME reached 281% last week. Volume has reduced but if shareholders hold rather than sell then this will result in low volume and doesn’t that intensity the squeeze? In a war of attrition the long position has no running cost but for the short it does and it is punishing. The bubble will of course burst but if the shorts have to exit before then it will be at their extraordinary cost. Have I missed something?

    1. Joachim Klement says:

      From Bloomberg: “Short interest in the video-game retailer plummeted to 39% of free-floating shares, from 114% in mid-January, according to IHS Markit Ltd. data. Data from S3 Partners, another market intelligence firm, showed a similar pattern, with GameStop’s short sales having fallen to about 50% of its total stock available to trade, down from a high of roughly 140% reached earlier this year.”

      1. AJH says:

        Thank you and noted. I feel for the retail investors. Many of them young and very wealthy if they gave up their solidarity and exited. C’est la vie. We have all learned from our losses.

  2. KC says:

    I tend to agree with ajh. While there are going to be many disappointed losers on the retail side most sources still cite short interest as being relatively high. With many retail investors buying and holding the number of actively traded shares available in the float is diminishing, meaning it is getting harder for shorts to close their positions. I would be interested to see why the author believes that shorts have already covered their positions as maybe he has information that is not readily available to the public?

    1. Joachim Klement says:

      See my answer to ajh

    2. Benjamin Watts says:

      Who shorted the stock on Jan 27th?

  3. TS says:

    The original investment by U/deepf***gvalue sounded a perfectly sensible investment position based on fundamental analysis. As he describes it – he spotted that lots of short positions existed beyond the free float, but that the company was cash generative and had sufficient cash to meet its obligations in full. Note this was at <$5 a share and over a year ago.

    Secondly the short positions were clearly overextended here due to the size of the shorts versus the free float. Therefore unless there was ultimately a bankruptcy, they were going to overall get themselves into trouble as there would be a short squeeze. Melvin Capital et. al. do not sound terribly clever in all of this.

    Thirdly the original options strategy adopted by Reddit was using cash settled call options which theoretically could have meant that a majority of Redditors got out ahead if I understand it correctly – even if the timing of the plan/ exit was very unclear. You could have seen the crowd drive the price into a specific call option expiry dates and then collapse. Coordinating this without committing pretty obvious market manipulation would however be difficult and it looks like it was never likely to be achieved.

    The Reddit strategy was hampered by the restriction on the purchase of calls options by investors on retail platforms. This was always going to happen as logically when the market was completely one sided and price volatility was exploding, the exchange which sits in the middle of this guaranteeing the options trades, was required to request significantly more margin. This they duly did last week and asked for $33.5bn overnight. As Robinhood and others are not very large players they were inevitably going to need to raise equity very quickly and stop selling call options on these specific stocks.

    Redditors believed they were being cheated by Robinhood and starts buying straight equity in the likes of GME/ AMC/ BB to maintain the exposure and fight the evil hedge funds. Now we are in the situation you describe Klement…the shorts will 'win' at some point, but in part because of natural feedback loops caused by the original strategy.

    An outcome of all of this might be lots of the retail brokerages facing solvency stress. So Reddit could end up trying to break hedge funds and end up putting their brokers into distress.

    One maybe interesting angle in all of this in the original trades – who was analytically correct? Were the hedge funds legitimately seeing a company who would go bust or was deepvalue spotting a company that was trading well below its fundamental value?

  4. Autist says:

    Except reddit users have specifically told everyone to turn off share lending by their broker.

    GME to $1000

    1. Angus says:

      I am just really concern about the people that have this thinking. Obviously the stock won’t reach that level. But even if it does go up, it will just mean the the fall will be harder.

  5. Fail to deliver says:

    Short interest is higher than ever before. S3 provided false data. GME 1000🚀🚀

  6. FCW says:

    “And many retail traders don’t know that they have signed terms and conditions with their custodians that allow them to lend the securities in their portfolios to other investors for a fee, none of which ends up in the traders’ accounts, of course.”

    I beg to differ on the part that you state so firmly that ‘of course’ brokers will not share the proceeds of securities lending with the asset owners. A 50/50 split of the securities lending fees after out-of-pocket costs is seen regularly and I have also seen a box to check on opening or changing a custody account if you want your securities to be part of a securities lending program. So I also have a problem with the part that many traders would not know about their securities being lent. The rest of the article contains the wise lesson that the long or short party is not over and the game is not won until you are in and out of your positions. Paper profits don’t buy anything in the real world unless you take out a loan against your asset (but that too has to be repaid).

  7. Option Circle says:

    I think the short-sellers have won and the retail traders lost.

    1. Not Closed only Delayed says:

      @Option Circle based on what may I ask. Remember the shorts may have
      “ Covered “ some positions. But they haven’t CLOSED their positions so millions of the shares are still borrowed floating around & being borrowed again with IOU’s.
      Until they pay & close this game is far from over. The depts are still outstanding & the shares are floating. At some point in time all these borrowed shares will appear as FTD’s & create attention from the FED & the DOJ.
      We are already seeing the DOJ conducting investigations to institutions & as a retail investor I welcome this.

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