This week, a Reddit mob sent Wall Street into chaos. It has been dubbed Occupy Wall St. 2.0 and Wall Street’s French Revolution.
Reddit is a social media site composed of hundreds of communities, ‘subreddits’ or, essentially, topics. Each of these communities has their own thread where ‘redditors’ comment and share images and videos related to the topic. One of these threads is called r/WallStreetBets.
The r/WallStreetBets community have, in the last year, started to target certain companies, buying stocks and causing their shares to surge. In the last few weeks, they focused on GameStop. GameStop is a bricks-and-mortar gaming shop that has struggled to keep up with the ongoing shift towards online gaming.
As a result of this GameStop vulnerability, hedge funds began to short sell their stocks in the company. I will explain below.
For the purpose of this article, when buying stocks, you have two options. The first is a long option. This is where, for example, you buy a stock in a company for $10. You buy this expecting the stock to rise in value. When this stock rises to a value of $20 you sell it and you have made a profit of $10.
The second is a short option. Short selling is essentially betting against the company. To short sell you borrow a stock, say it is worth $10, and you sell it. You do this under the agreement that you will return the stock to the original lender. You do this because you believe the stock will lose value. When the value of the stock reduces to, say, $5, you buy it back and you return the stock to the lender. You have made $5 profit.
In the case of GameStop, because of their perceived vulnerability, hedge funds such as Melvin Capital started to short sell their stock.
The risk is that the value of a stock can also go up. If you short sell a stock and it increases in price instead of decreasing, you still have to return the stock to the lender. The risk, theoretically, is infinite.
On the r/WallStreetBets subreddit, they noticed that hedge funds such as Melvin Capital were short selling GameStop stocks. So, they started to buy GameStop. As a result, the comapany’s stocks went up more than 700% in value from January 1st to January 28th. A year ago, shares in GameStop traded at $3.25 each. Yesterday, they were trading at $347.51.
As the price increased, Melvin Capital still had short options they needed to return to their lender. So, they had to buy stocks. This drove the price up even more. As a result of losses due to the incident, Melvin Capital were forced to secure an emergency $2.75 billion from rival funds.
On Friday, after Wall Street and the hedge fund world was sent into disarray, trading limits were put on GameStop stocks. The message from the Wall Street establishment was clear: we can play this game, but you cannot.
It played out as a David vs. Goliath battle, or the bourgeoisie almost overthrowing the monarchy. In reality, it was a blip, a fleeting moment where it looked like the little guy might win.
In the end Wall Street is too strong, the money is too much and the links to those in power too close. In the end Wall Street makes the rules, we just have to play by them.
— Jonathan Lewis (@lonnyjewis)