Bets against GameStop’s stock, followed by a campaign to juice the video-game chain’s shares, sent its stock price soaring before it tumbled Thursday when trading app Robinhood banned purchases.
The phenomenon involves two trends championed by individual investors in recent months — options trading and momentum investing — that have collided with the sometimes-controversial strategy of short selling.
This combination has led to high scores for some playing the market this week. Here’s what fed the dizzying rise and stomach-churning fall in GameStop’s stock price:
How does short selling work?
Short selling is when an investor sells borrowed shares of stock with the hope of buying the shares back later at a lower price. It is essentially the opposite of traditional investing aimed at profiting from a stock’s rise.
The GameStop story starts with short sellers who lost confidence in the company’s future as the pandemic challenged companies without strong digital strategies.
With short selling, investors make money if the price of a company’s stock falls. If the price rises, investors need to cover their positions by buying the stock back at a higher price. The losses can be substantial.
Here’s an example: an investor borrows 100 shares from a broker at $50 per share (plus a small fee for the transaction) expecting the company stock to go down.
Before the stock falls, the investor, or short seller, sells the borrowed shares and the proceeds of $5,000 are credited to their account.
If the price falls to say, $25, it will cost just $2,500 to buy the 100 shares back. The investor pockets $2,500.
If the price jumps to $75 by the time they must buy the shares back, it will cost them $7,500, a $2,500 loss.
What happened with GameStop stocks
Individual investors, buoyed by comments in the r/WallStreetBets Reddit community, began driving up the price GameStop on Jan. 11, when changes to the company’s board of directors suggested it might be embracing a digital strategy.
The rising share price put pressure on short sellers and their bets for declines in GameStop shares. Soon, they were forced to become buyers of shares they had sold short, pushing share prices even higher.
Individual investors added fuel to the fire, sparking this week’s exponential stock price increase by using call options to bet that the price would rise.
How do options work?
Call options let investors buy a shares for a set price in the future. The cost of the option is a fraction of the stock’s current price. If the stock price rises enough, the value of that option rises, and the investor can sell for a quick profit.
Put options are the opposite: A right to sell a stock at a set time.
The investor purchases either kind option from a market maker — an electronic trading company or individual that often purchases the same stock as a hedge against a rise in the stock’s price.
In the case of GameStop, market makers’ hedges likely helped fuel the stock’s surge.
How it all went down: a timeline of GameStop stock price and related events
September 8, 2019: Someone on r/WallStreetBets is already buying GameStop stock.
Dec. 31, 2019: GameStop stock (GME) closes at $6.08.
March 30, 2020: GameStop says it will close more than 320 stores in 2020. GME closes at $3.65.
Aug. 31, 2020: Ryan Cohen, a cofounder of Chewy.com, buys 9% stake in GameStop. GME closes at $6.59.
Sept. 8. 2020: Denizens of r/WallStreetBets had discovered short positions and prepared to wield their “choice of weapon… $GME.”
Sept. 10, 2020: GameStop revises estimate, says 450-500 stores will close. GME closes at $6.23.
Sept. 21, 2020: Cohen says he’ll talk with GameStop management to increase their online products, offer more merchandise and improve shipping time to customers. GME closes at $8.75.
Sep. 22, 2020: GME surges on reports that Ryan Cohen has taken position.
Dec. 8, 2020: Company says it will close more than 1,000 stores by March 2021. GME closes at $16.94.
Dec. 17, 2020: Cohen buys more shares of GameStop for a total of 9 million. GME closes at $14.83.
Jan. 11, 2021: Cohen and two colleagues join GameStop board of directors. GME closes at $19.94.
Jan. 12, 2021: Members of r/WallStreetBets, a group of individual investors formed on Reddit, are buying up GameStop stock. GME closes at $19.95.
Jan. 21, 2021: With GameStop trading around $40, Andrew Left, editor at Citron Research, tells Benzinga’s ZingerNation Power Hour that he expects GameStop stock will fall to $20 in near future. He says GameStop’s business is in “terminal decline.” GME closes at $43.03.
Jan. 22, 2021: Following an online backlash, Citron says it will stop commenting on GameStop’s stock and characterizes internet commentators as “an angry mob.” GME closes at $65.01.
Jan. 25, 2021, 4:08p.m.: Elon Musk tweets: Gamestonk!! GME closes at $76.79.
Jan. 26, 2021, 10:32 a.m.: Chamath Palihapitiya, CEO of Social Capital goes long on call options. “We bought Feb $115 calls on $GME this morning.”
Jan. 26, 2021: Citadel and Point72 infused Melvin with close to $3 billion to shore it up. Gabe Plotkin defends against rumors of bankruptcy filing. Melvin Capital, a hedge fund that is short-selling GameStop, closes its position on the company. GME closes at $147.98.
Jan. 27, 2021, 6:47 a.m.: Andrew Left, of Citron Research explains that they are closing their position. “Covered the majority of the short in the $90s at a loss of 100%”
Jan. 27. 2021: On the same day, Nasdaq momentarily halts trading on GameStop, AMC Entertainment and fashion retailer Express after trading reaches a level of extreme volatility. TD Ameritrade restricts trading on GameStop.
Jan. 27, 2021, 1:00 p.m.: TDAmeritrade sends this statement to USA TODAY: “In the interest of mitigating risk for our company and clients, we have put in place several restrictions on some transactions in $GME, $AMC and other securities,” said the company. “We made these decisions out of an abundance of caution amid unprecedented market conditions and other factors.”
Jan. 27, 2021: Chamath closes position. Defends individual investor rights to sway market like pros.
Jan. 27, 2021, 5:00 p.m.: SEC issues statement: “We are aware of and actively monitoring the on-going market volatility in the options and equities markets and, consistent with our mission to protect investors and maintain fair, orderly, and efficient markets, we are working with our fellow regulators to assess the situation and review the activities of regulated entities, financial intermediaries, and other market participants.”
Jan. 27, 2021: Social platform Discord bans the WallStreetBets server.
Jan. 27, 2021, 6:45 p.m.: r/WallStreetBets goes private.
Jan. 27, 2021, 7:45 p.m.: r/WallStreetBets is public again.
Jan. 28, 2021, 9:56 a.m.: Robinhood say they are ‘restricting transactions for certain securities to position closing only, including $AMC and $GME.’
Jan. 28, 2021, 11.28 a.m.: WeBull restricts activity on GME, AME, KOSS.
Jan. 28, 2021, 11:47 a.m.: On Twitter, Sen. Ted Cruz, R-Texas, agrees with statement by Rep. Alexandria Ocasio-Cortez, D-N.Y., that Robinhood’s restrictions were “unacceptable.”
Jan. 28, 2021, 1:13 p.m: Class action suit against Robinhood filed.
Jan. 28, 2021, 2:20 p.m.: Discord no longer banning WallStreetBets, says they are helping them with their new server.
Jan.28, 2021, 2:35 p.m.: WeBull says GME, AMC, and KOSS are no longer restricted.
At the end of trading on Jan. 28, that original r/WallStreetBets poster claimed to still hold almost $33 million in GME stock.
Other retail stocks followed the trend
Javier Zarracina, Janie Haseman, Paul Davidson, Brett Molina, Karina Zaiets, and Shawn Sullivan contributed to this report.