Last month I asserted that Bitcoin was perhaps the ultimate multiplayer game. I have to admit that I was incorrect in that assertion. For the past few weeks at least, a seemingly obsolete retailer of video games offered something far more entertaining to the masses than anything in its inventory. GameStop (GME) enthralled the masses.
It started with a cheat code. The folks at r/wsb identified a flaw in the mechanics of short selling. As we discussed last week, this was not only legal, but a bizarre side effect of the stock loan process. A dealer who receives shares does not know whether or not those shares are borrowed from someone else, and nothing prohibits him from unknowingly re-lending borrowed shares. Savvy posters on the site identified that the short interest in GME exceeded the available float, recognized that this was an untenable situation, and led a campaign to squeeze the short sellers.
While I firmly believe that short selling is a legal, ethical, and a necessary part of investing, it is fraught with risk. By definition it is a leveraged activity – shares sold short are borrowed – and adding leverage to an investment always increases its risk. The payoff structure of short selling is asymmetric as well. Stocks can’t trade below zero, but they can rise infinitely. That flips the risk/reward calculus of most investing upside down. To be fair, “infinite loss potential” has always been a largely theoretical construct. The GME saga made that notion much more tangible.
And while I think that short-selling has a valid role in market structure, I have no sympathy for the short-sellers who were burnt either. If short sellers fail to understand the risk inherent in their activity and fail to take steps to mitigate that risk, then the onus of their losses is theirs and theirs alone. Short sellers are typically a sophisticated bunch (or at least talk a good game), and can’t plead ignorance. The GME frenzy started as a short squeeze, and short sellers have been subject to short squeezes for as long as short sales have existed.
A special mention goes to AMC Entertainment (AMC) and its short sellers. The stock was heavily shorted in the $2-$5 range, though the short interest ratio was much lower than GME’s. What were the short sellers hoping to gain? They were clearly willing to risk a substantial loss with the hope of gaining a few bucks, less the substantial stock borrowing costs. Even though there were rumors that the company was flirting with Chapter 11 bankruptcy, were those rumors meaningful enough to justify the lopsided risk? In hindsight, clearly not – especially when the company was able to avert imminent disaster by raising money in the debt markets. That led to a meteoric rise in AMC shares. The move was not as dizzying as that of GME, but it was more entertaining than most of the movies that AMC shows in its theaters.
Of course, the GME story metastasized in ways that went beyond a typical short squeeze. While it may have begun in a fairly recognizable manner, the breadth of the squeeze and the mentality that accompanied it were unique to the current state of technology and public discourse. As we noted, much of the tone on r/wsb morphed from strictly about making money into a curious mix of populism and nostalgia. It is a gross oversimplification to say that the motivation was about “sticking it to the man” and “how dare they gang up on the companies that I grew up with”, but those sentiments had much to do with the situation going viral in the way that it did. Much of the media refers to the stocks that rallied along with GME as “meme stocks.” It is indeed a convenient way to describe them because a meme turned them from solid investment theses into a full-fledged mania.
Unfortunately for many investors, the GME saga is ending much differently than the games in its stores. The game players in the market won, yet no one told them “Game Over”. Or when they were told that the game was coming to an end, too many chose to keep playing. Just as I can’t understand why a short seller would attempt to bet on further declines on a $3 stock, I find it unfathomable why investors would fail to take profits on a stock that is up over 100%. Even after it was clear that the market’s PlayStation was overheating, too many kept playing the game. That is an unfortunate end for far too many.
While the GME game may have come to an end – at least for now – its after-effects will linger. New regulations are likely to arise, and we can only hope that they are sensible. But my most fervent hope is that the majority of new investors learn that while investing can be fun and profitable, it is not a game. Or if you treat it like a game, it can be extraordinarily frustrating and expensive.
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