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The current Wall Street Bets theory behind the $GME rally goes as following:

  1. Hedge funds have shorted Gamestop to 140% by re-borrowing the same shares multiple times (or some other equivalent mechanism)
  2. Some traders have noticed this being the case and started driving up the price of Gamestop shares
  3. Hedge funds are losing money over this because they have to pay more interest per stock and because they're being pressured to return the borrowed stocks due to the high price
  4. At some point in the near future (weeks if not days) they'll be forced to close their positions which would drive up the stock price to $1000+, thus creating a massive transfer of wealth to small time investors

Does the last point actually have credibility? Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

JonathanReez
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  • Note that this is not a duplicate of: https://money.stackexchange.com/questions/135411/can-someone-explain-the-gme-short-squeeze-situation-to-a-non-stock-trader. I'm asking about the credibility of a very particular claim from WSB, not about the situation in general – JonathanReez Jan 28 '21 at 17:30
  • "Couldn't short traders wait for many more months before closing their positions" -- Who would lend them stock while they wait for an inevitable price crash? The position can be closed from either side. – David Schwartz Jan 28 '21 at 17:47
  • Actually I am wondering who currently gets the billions from 3). Like is it know who lend out a lot of these stocks? – lalala Jan 28 '21 at 21:59
  • An important point to note here is endgame strategy. If you are holding onto millions worth of GME because you invested all your savings in December, what are you doing? Are you really waiting to hit 1000$ and risk losing everything if this does not happen? Remember this is a 'once in a lifetime' gamble gone right. It takes a lot of optimism and nerves not to cash in (at least partially) and indeed prices now seem to "stabilize" in the 300-350$ range – Manziel Jan 29 '21 at 16:04
  • @Manziel that's the million dollar question, yes (literally for some like /u/DFV) – JonathanReez Jan 29 '21 at 16:11
  • I guess it comes down to, do you think Melvin Capital has won or lost? If you think Melvin has won, by closing their position cheaper than all the other shorters who will have to pay $1000, then your plan might be to hold. Doesn't mean it's right, but that's the obvious plan for those who agree with the $1000 figure. If you think Melvin has lost, by closing close to what you calculated the peak would be, then you already sold back then, and you're out. If you have no idea what the peak should be but are scanning the internet for theories and rumours: congrats, you're holding a bubble. – Steve Jessop Jan 29 '21 at 19:23

5 Answers5

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Hedge funds are losing money over this because they have to pay more interest per stock and because they're being pressured to return the borrowed stocks due to the high price.

The cost to carry a short position in GME has increased for two reasons:

  • The daily borrow rate for GME has increased in the past few weeks
  • The share price has increased

However, this is not an unbearable cost or loss. The primary reason for the large losses is share price moving against them. If you short at $20 and GME hits $350, you're down $330 if you can hang in there.

At some point in the near future (weeks if not days) they'll be forced to close their positions which would drive up the stock price to $1000+, thus creating a massive transfer of wealth to small time investors.

Several hedge funds have already closed their positions and taken their losses. Probably many traders as well.

Bear in mind that there are other factors in play as well. Any Redditor looking to cash in has to sell some or even all of his position. That drives price down. As price drops, that enables option market makers to sell shares as well (purchased to hedge their short calls). I would imagine that new short sellers are also coming in at higher prices as well.

The confluence of these drives price down, as seen today from maybe $485 to $112. And then the buying pressure resumes and it's back up to $240. While $1,000 is possible, I think that it's also possible that at some point, new hedge fund money comes in short and crushes those still playing the game. Not a prediction just saying that price volatility is not likely to be over any time soon.

Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

The margin requirement is the primary determinant of being able to keep a short position open during a short squeeze.

Bob Baerker
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    "Several hedge funds have already closed their positions" => do we have proof that they've actually closed rather than merely saying they've closed? – JonathanReez Jan 28 '21 at 18:07
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    "this is not an cost or an unbearable loss." Did you forget a word in "an cost"? – RonJohn Jan 28 '21 at 18:14
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    Added a follow-up question: https://money.stackexchange.com/questions/135491/is-there-a-way-to-confirm-if-a-hedge-fund-indeed-closed-their-short-positions-on – JonathanReez Jan 28 '21 at 18:21
  • @RonJohn - Just a lack of proofreading on my part before positng – Bob Baerker Jan 28 '21 at 18:57
  • @JonathanReez - do we have proof that they've actually closed rather than merely saying they've closed? Any exposed hedge fund interested in being able to remain solvent during this short squeeze would have pared down its positions long before today. – Bob Baerker Jan 28 '21 at 19:01
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    @BobBaerker but can any third party confirm if they actually did so in practice? – JonathanReez Jan 28 '21 at 19:02
  • "Just a lack of proofreading". Been there, done that. Didn't want to assume what you really meant. – RonJohn Jan 28 '21 at 19:04
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    Due to comments, I usually circle back, read my posts again and edit typos I always miss some. For those, I appreciate all assistance :->) – Bob Baerker Jan 28 '21 at 19:08
  • Is it possible that gamestop issues more shares? – lalala Jan 28 '21 at 22:00
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    @lalala no. That takes time and there a regulations to follow. – RonJohn Jan 29 '21 at 00:18
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This is the story WSB is telling:

There are two PS4s. Alice has one, Eve has one. Herbert knows that with the PS5 release, the price of a PS4 is going to fall from $300 to $100. So, Herbert borrowed Alice's gadget and sold it to Bob for $300. He planned to buy it back off Bob when the price fell and give it back to Alice. So far so good. Herbert got greedy, though, and then borrowed it back off Bob and sold it to Charlie.

Now, Eve looks at the situation and posts loudly on the internet "Herbert owes two PS4s. There only are two PS4s, and I have one. So Herbert has painted himself into a corner: he needs my PS4, and I can charge him whatever I want. Sure, he can have it. For 3 grand. No, 30 grand. I can literally make up numbers at this point."

It's a good story.

However, Herbert ignores her. He knows he's messed up, but he also knows she's wrong. He doesn't need her PS4 in particular. So, he goes to Charlie. "Hey mate, that PS4 I sold you, could I have it back? I'm really sorry, something's come up. I'll give you $600." Charlie says "sure". Then Herbert goes to Bob and says "Hey mate, here's that PS4 I borrowed. But actually, do you think I could buy it off you? I'll give you $600." And Bob says "sure". Then Herbert goes to Alice, and gives her the PS4 that he borrowed.

And Eve is left shaking her head in a disappointed sort of way.

What happened, at core, is that Eve thought Herbert owed two PS4s, and so the number of physical PS4s was some sort of hard limit on how he could fix things. Instead, he owed two PS4-transactions. He'd sold a PS4 twice, even though it was the same PS4 and wasn't really his to sell. So now he has to buy a PS4 twice to balance it, but it can be the same PS4 that he buys both times.

The most important lesson for us is, be careful when Eve says that we can buy her PS4 for the low low price of £1000 and Herbert is guaranteed to buy it off us for whatever we ask. We might wind up just giving Eve a grand for an outdated bit of tech and have nothing to do with it except put in in the cupboard.

There is of course some sense in which the story is true. Herbert does need to pay over the odds to fulfil his obligations. But he doesn't need to pay Eve. He needs to pay whoever will give him the best deal. If Eve and Charlie agreed that they won't sell for less than thirty grand, he'd have to pay one of them thirty grand. But that's illegal. And without a binding agreement, it's in Charlie's interest to be reasonable so that he gets the sale rather than Eve. So Charlie gets the sale, and Herbert doesn't have to blow £30,000 on a cupboard filler.

Josiah
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  • And Bob says "sure" => what if he says no? – JonathanReez Jan 29 '21 at 13:18
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    Charlie and Eve don't have to agree, the price is listed in the open and they can both see it's currently sitting at £30K – Jontia Jan 29 '21 at 13:22
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    It's not $30k. No-one trades at £30k. The last trade was $300. Eve may advertise that she'll sell for 30k, just like Herbert may advertise that he'll buy for 10¢. Neither is the market rate. – Josiah Jan 29 '21 at 14:56
  • @JonathanReez, the basic assumption of the market is that people are in it to make money rather than to play mariokart. Bob won't say "no" but he might say "Not for $600, but $750 will do." Of course in a real market there are a lot more than 4 players, and the embarrassed shorter will get matched with the set of people willing to take the lowest (but still bolstered) price. – Josiah Jan 29 '21 at 17:15
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    Where Herbert really runs into trouble is when the story continues with "Herbert got greedy, though, and then borrowed it back off Bob and sold it to Eve (not Charlie)". So Eve is the only one in possession of any PS4s. Even then, Herbert is not required to buy one from Eve at the price she chooses. He can make a deal with Alice to buy back his IOU that she is holding. – Ben Voigt Feb 01 '21 at 17:40
  • @BenVoigt, Yes, I meant to add that last point, but it seemed too technical for the tone I wanted. The effective sellers (that shorters as a group could turn to) are: everyone actually holding the item, and everyone who's owed the item. It's this last part being the numerator as well as in the denominator which means you can't actually catch someone owing more than 100% of possible sources. – Josiah Feb 01 '21 at 23:04
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    @Josiah: With options, closing by dealing in the option contract is common and well-supported. With stocks I don't think the people who loaned out the stock actually are sellers, at least not in a way that helps Herbert. Because the seller who loaned out the stock (Alice) has to have actual ownership in time for settlement, which means she demands back the stock he loaned out before settlement, and that's a problem for Herbert since he won't actually have it back until after settlement. – Ben Voigt Feb 01 '21 at 23:17
  • The problem with the last part (illegal collusion to fix prices) is that the open market sets the price for GME, which breaks the analogy. That's the whole point of capitalism - if trades happen in the open, where offers and bids are visible, price coordination happens automatically as buyers and sellers are matched. – MSalters Feb 02 '21 at 13:49
  • Nicely said. Whether the short interest is < or > 100% seems entirely irrelevant to me. The question is whether the squeezer (Eve) controls < or > 100% long interest. – Fab Feb 03 '21 at 20:36
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    @Josiah: While the price at which the last trade occurred may be the "market price", what really matters are the highest price of any pending limit order to purchase the item and the lowest price of any pending limit order to sell. If Bob sells Joe a PS4 for £4000, and then other people enter the market who would sell for £1000, but nobody other than Bob is interested in paying more than £400, the last-trade price will sit at £4000, but that will be an essentially meaningless figure. – supercat Feb 05 '21 at 17:01
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Does the last point actually have credibility? Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

They can, if they have enough money (and can demonstrate it to the broker).

Let's say you sell a stock short at $10, but later it rises to $100. If the broker can see you have $100 available, then they'll be OK with you maintaining your position. But if you can't - they logically are going to do what is known as a "margin call" and demand you either close your position or add more money to your account.

Short selling is dangerous because there's no limit to how high the stock can go. If you buy a stock for $10, your maximum loss is $10. You can never get a margin call this way (assuming you don't leverage, which means borrowing money from the broker to buy the stock). But if you short sell the stock, you can lose $90 as in the example above, or even more if the price keeps rising.

GME stock has gone up by a huge amount, so it's not surprising that the original short sellers were forced to cover their positions.

Allure
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    The broker would probably require you to have more than $100, they'd want the $90 you'd already lost, plus some more to cover any losses they may incur if the security continues to rise and you don't have enough funds - if they decide you can no longer afford to hold the position they'll close it out which could incur more losses – David Waterworth Jan 29 '21 at 05:33
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Does the last point actually have credibility? Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

Yes, because of either getting margin called or rather untenable positions (e.g., a >1G USD potential loss).

In the case you mention, WSB short squeezing $GME, investment management firm Melvin Capital seems to have lost a few billions as a result of their short GME positions. See Citadel, Point72 Back Melvin With $2.75 Billion After Losses.

Franck Dernoncourt
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Please please please ensure you understand the risk in trying to jump on a volatile bandwagon like this.

A statement like "At some point in the near future (weeks if not days) they'll be forced to close their positions which would drive up the stock price to $1000+, thus creating a massive transfer of wealth to small time investors", posted even after price dropped from $400+ to $200- today is a sign that you may have neglected to consider the actual risk taken on by assuming this is a 'sure thing'.

The whole GME situation smells to me like a lot of uninformed individuals putting more money on the line than they should be. I would also suggest that the driving force behind the price jumps are from individuals who stand to gain many Millions from the increases. Don't believe everything you read online...

Grade 'Eh' Bacon
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    I'm not a $GME investor, just trying to understand the credibility behind the theory. Lets focus on facts rather than generic warnings about the stock market being nothing more than a glorified casino (in the short term, at least). – JonathanReez Jan 28 '21 at 18:09
  • @JonathanReez Please show where I used the line 'glorified casino'? The facts show that price dropped from $400 down past $200 [though picked up back to $250 by the time of writing this comment], which is important to say in reference to your supposition that price will just continue rising to $1k. This site has had a lot of interest from underinformed investors and I consider it paramount importance to highlight when an overly optimistic statement like that is made. – Grade 'Eh' Bacon Jan 28 '21 at 18:15
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    note that (A) even $200 is a massive transfer of wealth to small time investors and (B) they are trying unusually dirty tricks to force the price down. – user253751 Jan 28 '21 at 19:32
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    @user253751 You misunderstand the situation. Redditors are buying shares at $100-$400, which in a week will probably be worth close to their old $20/share price. The short squeezes will provide an immediate price climb (which has largely been what we've seen thus far), but sooner or later, people will be holding shares that cost 10x what they are worth. The only 'wealth transfer to small time investors' will be those with ""WEAK HANDS"" who sell before the full price drop. – Grade 'Eh' Bacon Jan 28 '21 at 19:51
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    @Grade'Eh'Bacon if the short squeeze succeeds, it guarantees a wealth transfer from short sellers to non-short-sellers; it does not guarantee which of the non-short-sellers receive it. If you are not a short seller then - under the assumption the squeeze succeeds - it's a non-zero-sum game for you. – user253751 Jan 28 '21 at 20:01
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    @user253751 Correct - and of the non-short-sellers, who do you think will actually be left with a fat check at the end? Those with more market knowledge who step out early and leave others holding the bag, all while riling up the less informed by screaming "MOOOOOON" on Reddit. That doesn't result in a wealth transfer in the way you are looking for. – Grade 'Eh' Bacon Jan 28 '21 at 20:02
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    isn't asking questions like this the way to "ensure you understand the risk"? – thehole Jan 29 '21 at 04:42
  • @Grade'Eh'Bacon: the way I understand it, in a typical investment bubble you rely on a "bigger fool" if you want to cash out and profit. In this investment bubble, the "bigger fool" is someone with a short position which you somehow know they will be forced to close before the crash. The question then is how do you know on what timeline the hedge fund will have to close? The fact the short exceeded the float was held to be significant, since it means price would certainly have to rise to close the positions. – Steve Jessop Jan 29 '21 at 12:41
  • Of course it's possible that amateur traders will hold on too long, but presumably some amateurs have already taken their wins. Piling in now is clearly a very different proposition from what piling in at $30 was a few days ago. Especially since we know (well, to all appearances it seems that) some of those bigger fools have already closed and taken the losses. So there's already much less available to take than there was. – Steve Jessop Jan 29 '21 at 12:41
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    And sure, anyone who bought Gamestop without some idea how to figure out what the "correct" time to step out was in order to catch the short positions closing, isn't playing the "amateurs vs hedges" game that made the news. Instead they're playing a regular investment bubble, and have the usual chance of losing. What's novel about this game is precisely the alleged market knowledge, published via Reddit etc, that there's an opportunity to catch shorters. If you're not using that, you're not playing the new game. – Steve Jessop Jan 29 '21 at 12:46
  • @SteveJessop Jumping in on a bubble, knowing it's a bubble, 'because I'll jump out before the other guy' is the definition of naive investing. Total market price dropped from $430 to $180 over about 45 minutes yesterday [price has remained volatile since then]. Much of that price change was 'gapped' meaning if you saw it at $350 you still couldn't jump out for more than $250, because no one was buying between those price points. And even if you do exit profitably, that means you just passed your worthless bag onto someone else. A dicey game. – Grade 'Eh' Bacon Jan 29 '21 at 14:16
  • @SteveJessop Remember as well - if the price rises to $900, and you're waiting for someone's short to close at $950, another hedge fund with an extra $1b could just enter new shorts which they wouldn't need to close [at a 30% margin requirement] until let's say a price of $2k. The person doing the buying is overpaying on stock deliberately to close out positions, that, if they stay liquid, are the more profitable decisions. – Grade 'Eh' Bacon Jan 29 '21 at 14:18
  • How does this answer the question? – Carsten S Jan 29 '21 at 15:42
  • @CarstenS Because the importance of warning about misunderstood risk outweighs duplicating another fantastic answer by Bob Baerker. – Grade 'Eh' Bacon Jan 29 '21 at 15:46
  • In short, it doesn’t. – Carsten S Jan 29 '21 at 16:03
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    If someone asks "Would hitting my head with this hammer hurt the hammer?", a pretty good answer would be "Please don't hit your head with a hammer, that has a lot of risk", even though the technically-correct answer would be "If the hammer is weaker than your skull, yes it could hurt the hammer". – Grade 'Eh' Bacon Jan 29 '21 at 16:30
  • "that means you just passed your worthless bag onto someone else" - exactly. Specifically, the object of the exercise was to pass the worthless bag on to Melvin Capital. Who claim that they accepted that worthless bag and wrote off the loss. Are you saying they're lying? Obviously I don't know how many amateur investors have won or lost, but the question was "is there credibility", and the fact appears to be that someone has taken money from Melvin Capital. Are you saying that's definitely another hedge fund? – Steve Jessop Jan 29 '21 at 18:17
  • And it should be fairly obvious that since Melvin no longer has a short position on Gamestop, it's no longer possible for anyone to take any more money off them that way. So it's not "if the hammer is weaker than your skull", it's a question of "some guy already broke a particular kind of hammer that way yesterday, and if you can find another one of that kind of hammer maybe it could happen again. Doesn't mean every hammer is of that kind". – Steve Jessop Jan 29 '21 at 18:19
  • Or to put it another way, the question is not "are you tipping Gamestop?", the question is, "could more hedge funds suffer the way Melvin has already suffered?". To which you appear to be answering that they all have deep enough pockets, sufficient nerve, and hence sufficient ability to maintain their short position long enough, that none of them will. – Steve Jessop Jan 29 '21 at 18:26
  • @SteveJessop Of course, anyone who was squeezed out of their short position [even a massive hedge fund], could lose in a situation like this. But many, many retail investors who bought on the way 'up' and find themselves unable to to sell on the way 'down' will also lose, and those losses can be proportionately more devastating [especially if anyone borrowed money at credit card rates to jump into the fray, as an example]. Remember that 'having nerves of steel' just means that you wont sell your position - it doesn't guarantee that the price rises enough for the squeezes to happen. – Grade 'Eh' Bacon Jan 29 '21 at 18:29
  • @SteveJessop Something else to mull over - if this was a 'sure thing', why wouldn't a competing hedge fund just plop down $500M to buy shares and squeeze out every single short seller? I submit for consideration that the fact this hasn't happened is the simplest proof that it is not as guaranteed a plan for success as is being posited on reddit. – Grade 'Eh' Bacon Jan 29 '21 at 18:31
  • My best-guess answer to why hedge funds do not attempt to play these traps against the short positions of others, is: (1) anyone playing this "amateurs vs hedges" game gains some non-cash utility from the prospect of hurting shorters. Competing hedge funds don't; (2) a single entity acting to monopolise the float is at more risk of being pinged for market manipulation in a way that a few tens of thousands of individuals, albeit acting with some co-ordination, won't be; (3) actually they sometimes do, and I just don't know about it. – Steve Jessop Jan 29 '21 at 18:36
  • And yeah, "guaranteed plan for success" is wrong. "There is no credibility at all to this because short traders can just hold their positions for many months", which is the null hypothesis of the question, is also wrong. – Steve Jessop Jan 29 '21 at 18:37
  • @SteveJessop You are suggesting that these hedge funds care more about 'the spirit of class warfare' than cutthroat individual profit. An individual trader with a book of $100M and the ability to use it as s/he sees fit could stand to make massive massive sums of money if the principles Reddit is describing are foolproof, but it hasn't happened. Of all the conspiracy theories I will never believe, at the top of the list is that a single profit motivated individual or entity will, for the first time in their life, give up the money for the sake of their 'convictions'. – Grade 'Eh' Bacon Jan 29 '21 at 18:38
  • @Grade'Eh'Bacon: no, I'm saying precisely the opposite, which is that these particular amateur traders care more about "the spirit of class warfare" than the hedge funds do. Hence, they are taking a risk which a hedge fund wouldn't take. I'm also saying that they're less likely to go to jail for taking it. Although tbh I don't know whether this scheme would be illegal if perpetrated by a single trader, I just suspect it might be. – Steve Jessop Jan 29 '21 at 18:38
  • @SteveJessop Exactly - and as such, any competing hedge fund with a coordinated, massively funded share purchase plan [rather than general reddit rabble scrabbling together next month's rent cheques] would be able to do the same thing, better, and quicker. But it hasn't happened. You can hold GME shares with adamantium hands, if you like, but that still doesn't mean the price will rise, and further, it doesn't mean that you will be able to eventually sell when it does. – Grade 'Eh' Bacon Jan 29 '21 at 18:40
  • That's an interesting historical claim, that no hedge fund has ever taken advantage of another hedge fund's short position to squeeze. I have no idea whether it is true :-) I don't even know whether any funds that weren't shorted have bought Gamestop in the last few days or, if they did, whether and where they sold. – Steve Jessop Jan 29 '21 at 18:42
  • And there is of course a general argument that can always be made: "if it was possible to beat return Z doing X, while sticking to risky Y, then someone has already done X and taken all that profit. Hence the only way to beat return Z is to increase risk above Y". Pretty much just the efficient market hypothesis. People who don't believe this is always inevitably true are: (a) high frequency traders, who aim to be the "someone" who has already done it; (b) people who think a specific "someone" has made a specific mistake. Which Melvin may have done. – Steve Jessop Jan 29 '21 at 18:47
  • @SteveJessop Not that a short squeeze has never been profitable / never been done by a competing firm - but that it hasn't happened now in a way public enough to push all squeezes out [after all, when institutional investors could still buy but some retail apps couldn't, the buying didn't continue, right?]. I – Grade 'Eh' Bacon Jan 29 '21 at 18:47
  • @SteveJessop Melvin making a mistake [far overloading their risk by taking on shorts of a stock 140% shorted, to my understanding, without any hedging through options], does not mean squeezing Melvin will make you as an individual money. Some people will make money on the squeeze, but only if they sell lower than they bought. And not everyone will do that [I would theorize that nearly zero people will make money, and those who do will rake in millions, a la reddit u/deepfuckingvalue, who largely led this charge from the first place and, to my understanding, already cashed out $10M+]. – Grade 'Eh' Bacon Jan 29 '21 at 18:49
  • @Grade'Eh'Bacon they will make money selling lower than they bought ? I think the wallstreetbets guys are trying to make money by doing the exact opposite.. – Claudiu A Feb 02 '21 at 09:29
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    @ClaudiuA Whoops that's a typo - buy low sell high. Can't edit comments unfortunately. – Grade 'Eh' Bacon Feb 02 '21 at 14:00