by As Gamestop stock continues to soar, new millionaires are being minted seemingly overnight. But who’s actually getting rich from Gamestop? And is there anything we can learn from these newly rich Gamestop shareholders?
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Who’s Getting Rich from Gamestop
Gamestop stock is on a tear. As of the end of January 2021, it is up 1625% for the year. Yes, in just one short month it has increased 1625%!
A $1000 investment in Gamestop on January 1st would be worth $17,250 just 29 days later.
Keith Gill, the YouTuber known for promoting the potential for a short squeeze showed that he is up $31.5 million on a $755,000 investment he made in GameStop shares and call options.
GameStop’s largest individual shareholder, Ryan Cohen, has seen his 13% stake increase in value by more than $2 billion over the past two weeks.
GameStop investor Donald Foss has seen his 5 percent stake in GameStop increase by about $800 million, while GameStop CEO George Sherman’s 3.4 percent stake is up about $500 million.
Source: Daily Mail
If you’re anything like me, you probably read these stories and had severe FOMO (Fear-of-missing-out). How did everyone get rich but you?
First, Mr. Gill waged a significant amount of money to buy extremely risky options. Gamestop, by most measures, is not a successful company and does not have a bright outlook. It was trading at less than $5 a share in August 2020, just 6 months ago. Now it’s trading at over $300 a share, completely out of whack from reality. Gamestop is facing severe competition, and according to it’s latest quarterly report, plans to shut down multiple storefronts in a cost-saving measure.
Mr. Gill’s bet on Gamestop was akin to buying a lottery ticket with a low probability of winning. A $755,000 lottery ticket that he could have just as easily lost!
It wasn’t just his bet that made him successful. If he just bought the options without telling anyone, he probably wouldn’t be sitting on millions (on paper) today.
He was posting about his trade on the subreddit Wallstreetbets and on Youtube. Some days he would be up millions, other days he would be down. He shared his trials and tribulations with the world.
Others, tempted by the lure of quick money jumped onto the wagon and piled into Gamestop.
Before this, institutional investors like hedge funds were extremely bearish on Gamestop. They thought that Gamestop was the next Blockbuster Video, and placed massive bets to short the stock. In fact, Gamestop was the most heavily shorted stock, with a short interest of over 100%!
As retail investors from Wallstreetbets jumped into Gamestop, the demand to buy increased the stock price.
Who’s Losing Money from Gamestop
As stock prices increased, the value of the short position stocks (betting that the stock will decrease) decreased.
Shorting a stock can be extremely dangerous. The upside for shorting a stock is 100%, but the downside could be near infinite.
Understanding the downside risks, some short sellers panicked and liquidated some of their holdings. In order to liquidate their holdings, they had to buy shares from the market to close their short positions, increasing the demand for shares and increasing the price even more!
This created something like a perpetual short squeeze machine.
When the stock price goes up, short sellers get scared and close their positions, increasing the price even more. The increasing price scares even more short sellers, who also sell, which increases the price even more. The cycle continues almost as if perpetually.
At least one hedge fund has closed its short position.
Melvin Capital closed out its short position in GameStop on 1/26 afternoon after taking a huge undisclosed loss, the hedge fund’s manager told CNBC.
But many other hedge funds aren’t budging.
Short-selling hedge funds have suffered a mark-to-market loss of $19.75 billion year to date in the brick-and-mortar video game retailer, according to data from S3 Partners. Source: CNBC
GameStop remained the most-shorted name in the market as short interest as a percentage of shares available for trading stands at 113.31%, S3 said.
Even as some people close their short positions, others are piling in. It would not be surprising to see the stock rise even further in this perpetual short squeeze machine, putting hedge funds in even greater danger.
If you may have noticed, the trading and speculation of Gamestop is pretty much a zero-sum game.
Yes, Youtuber Keith Gill, GameStop’s largest individual shareholder Ryan Cohen, and GameStop CEO George Sherman’s have made tremendous gains thus far. But their gain is at the expense of hedge funds who have lost close to $20 billion year-to-date.
At the end of the day, these gains and losses are on paper only until their positions are closed out.
But it will be very interesting to see how long each side can hold on before budging.
Paper Gains/Losses
We need to understand that paper gains and losses are not realized gains and losses.
If a trader holds a stock that is up 100%, she is only up that much on paper. That is, until she closes her position by selling the stock and realizes the 100% gain. Only after she sells is the money actually hers, and no one can take that money away from her.
But with the wild swings in stock prices, a 100% paper gain today, can shrink to a 50% paper gain tomorrow, to eventually a 0 or even a negative realized return. Nothing is guaranteed until the position is closed out.
As of right now the retail investors are up billions, while the hedge funds are down billions. But these are only paper gains and losses. If Gamestop drops 90%, there will be a wild swing in the other direction. At that point the hedge funds could all but completely wipe out the gains from the retail investors.
At this point in time, the frenzy surrounding Gamestop is zero-sum trading, not investing. In zero-sum trading, the buyers are up whatever the sellers are down. For every 1 billion that the retail investors are up, the hedge funds are down 1 billion (or close to it). This is different from investing in a solid company that tends to be priced according to its fundamentals. When you invest in a solid company, the company brings in profits and shares them with the shareholders. That’s not happening at all with Gamestop. It’s share prices are reacting to sheer speculation, not on fundamentals or profits.
Extraordinary Conditions for Success
Keith Gill did something extremely risky, and everything had to line up just perfectly for the best case scenario to pan out.
He wagered a LARGE amount of money on a RISKY bet on a STRUGGLING company with THE HIGHEST SHORT INTEREST. He convinced hundreds if not THOUSANDS of other people to pile into the stock, boosting the price and starting a PERPETUAL SHORT SQUEEZE MACHINE.
If you take away just one of the capitalized conditions I listed above, the story and his results would be far less remarkable than it is today.
David vs. Goliath Story
Many news outlets have dubbed this a modern day David vs. Goliath story. Regular people on Reddit have taken on the big money making hedge funds and are thus far winning. The traditional Goliaths, the hedge funds, have for decades made billions from equity markets while many average Joes don’t have much to show for it. In a complete reversal, now the average Joes are making millions while the hedge funds are losing billions.
But we can’t be so sure. We don’t know who’s on which side of the trade. Maybe many hedge funds follow Wallstreetbets and also got in on the buy side action early. Maybe many retail investors think this is a bubble bound to burst and have gotten on the short side. Aside from what’s being broadcast in the news, it can be tell who is David and who is Goliath.
Can You Make Money Now from Gamestop?
Gamestop is at its all-time highs. Should you buy it and carry that momentum to future gains? The answer is probably not.
Gamestop stock price is completely removed from its fundamentals. It is a struggling retailer which failed to make a profit last year, and has a rather bleak outlook for the future due to fierce competition and the rise of digital downloads. Its stock price is reminiscent of companies during the 2000 tech bubble.
OK, so if it’s a bad idea to buy the stock, then it must be a good idea to short it? The bubble could pop any minute and you could make a lot of money right?
It’s true that the bubble could pop. But Gamestop still remains the most heavily shorted stock in the U.S. stock market today. That means that even though some sellers like Melvin Capital have closed their positions, other short sellers are now jumping in. The perpetual short squeeze machine could continue to drive the price up for who knows how long. That presents extreme downside risk to any short position.
OK if it’s a bad idea to buy the stock, and a bad idea to sell the stock, what if I bet on its volatility through stock options?
A bet on volatility would mean that you don’t really care if the price goes up or down, as long is the magnitude in the difference from today’s price is rather large.
To bet on volatility you would buy a call option and a put option. One will expire worthless, while the other, hopefully will be worth more than enough to cover the cost of your two options, along with additional profit.
However, the premiums on Gamestop options is extremely overpriced. Not only that but you can’t tell with any certainty what the stock price will be a month from now or two months from now. It could go on a roller coaster ride and end up back where it started. At that point, you would lose money on both your call option and put option.
So if it’s a bad idea to buy, sell, or bet on volatility, what should you do?
The best answer I can give you is to make some popcorn, sit back, and enjoy the show! This is like a modern day financial soap opera. Who will win? The average joe Redditors or the billion dollar hedge funds? How long can the hedge funds hold on before panic selling? Will short sellers keep piling in? Will the stock price really shoot to the moon? How will regulators react to WallStreetBets?
It’s an exciting time to watch it all unfold. Some sides will lose money, some will gain money. But both sides are taking an enormous amount of risk.
Bottom Line
The Wall Street Fat Cat recommended way to success is not through speculation or market timing, but by continuing to dollar cost average low cost index funds. Don’t fall for the get rich quick hype. For every million dollar winner in this Gamestop spectacle, there is million dollar loser.
