If you haven’t been living under a rock, you’ve probably heard about Gamestop in the news or on social media lately. A Reddit group called WallStreetBets has taken on a large hedge fund, and so far, WallStreetBets is winning.

What is happening?

A hedge fund, Melvin Capital, believed that Gamestop’s value would decrease or that the company would collapse. They bet millions that the share price would be lower than it was at the beginning of the year, also known as a short.

Some individuals noticed that Gamestop had many shares shorted, and they wanted to make the hedge funds lose money by increasing the share price. Share prices are driven by demand, so the more people want to buy them, the higher the price will be. To increase a share price, it could take hundreds of millions of dollars depending on the size of the company.

People on the WallStreetBets Reddit started discussing this and saying that they wanted to buy Gamestop shares to increase the price. Enough people got on board and bought Gamestop shares, resulting in a significant price increase, over 16 times the price since January 12, 2021.

If you bought 10 shares of Gamestop on January 12, 2021 (at $19.95 per share), your investment of $199.50 would now be worth $3,250 (at the current price of $325).

We don’t know exactly what price Melvin shorted. For example, if Melvin shorted 1 million shares at Gamestop’s January 1st, 2021 price of $17.25 ($17.25m), to close out their position when Gamestop shares are valued at $325 today would cost them $325m. They would stand to lose $307.75m!

What is a short?

A short position is when someone sells shares they don’t currently own and intends to buy them back at a future date, pocketing the difference if the share price decreases. If the share price increases from when they entered the short position, they would have to pay the difference.

For example, you believe that shares in Gamestop are going to go down as you believe they are over-valued and the company may report worse than expected sales. Shares are currently valued at $325 and you sell 1,000 of these shares without actually owning them (short), and often borrowed from a brokerage. That means you have gained about $325,000 because you sold 1,000 shares. However, at some point in the future, you must buy back the shares.

The price goes up on day 1 to $350 which means that if you closed your short position on day 1, you must pay $350,000 for the shares, losing $25,000. An important rule here is that you must have $350,000 to pay back.

On day 2, the price goes down to $100. If you closed out your short position today, buying 1,000 shares would cost $100,000, and you would therefore make $225,000 from your short position.

What is happening now?

According to the news, Melvin has closed out their short position taking huge losses. Many people on the Reddit group don’t believe this has actually happened, or now believe Melvin have taken out a new short position at the high price, expecting it to fall.

The group on Reddit are encouraging everyone to hold their shares and buy more if the price drops. It remains to be seen what happens at the weekend, but someone has to lose money.

What do I believe will happen?

There is no way that this share price will maintain long term. Gamestop are currently valued at $22 billion based on their share price, which is not a true reflection of their value. It is very high risk to buy Gamestop shares at the lofty valuation currently seen. The likely outcome is that the share price will maintain, maybe even grow over the next couple of days. But all it takes is a big fish (large hedge fund) to sell many shares and move the price down by several percent. The psychological impact of this reduction may trigger a large sell-off, and the price will reduce quickly. Nobody knows when this will happen, but it is likely the current share price will only be short term.

If you have made money on Gamestop, well done on taking a gamble! I would urge anyone looking at buying Gamestop shares now to proceed with caution. It’s a huge risk and it will take a huge amount of money to move the share price by multiples of what it is currently at.

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