The chatter about video game retailer GameStop (GME) and traders on Reddit has been bubbling over the past week and finally spilled over from the finance world to the mainstream. Here’s what’s happening:
What or who is ‘WallStreetBets’?
WallStreetBets is actually “r/wallstreetbets” and it’s a forum or “subreddit” on the popular website Reddit, which is a social platform and discussion group that also rates web content.
Essentially, it’s a group of people who enjoy talking about investing and often, speculative investing. Given that it’s on Reddit, it is accompanied by traditional Reddit-house style, which often includes profanity, irony, and a tremendous dose of memes.
Users are generally regular people who are trading and speculating, but they’ve occasionally found and exploited key weaknesses in Wall Street or in financial products.
As of this week, it had around 2.9 million “degenerates” (what subscribers call themselves) and as of writing 726,000 were viewing the forum.
What’s an option?
An option is a contract you can buy that lets you buy or sell a stock at a certain price. For example, you pay a small price for the right to buy a share of a stock like GameStop for an agreed price at some date in the future. For speculators who think a stock might rise, it’s a way to get a far greater profit than simply buying the stock.
What are they doing to the market?
Wall Street Bets isn’t an organized group with a leader, but the community sometimes comes to consensus when a convincing argument is put forth. When that happens around a stock that has a smaller market cap, wild things can happen.
For example, their activity and influence can be enough for shares of bankrupt companies like Hertz (HTZ) to spike, which actually led the company to try to issue new stock in 2020 even though it was bankrupt and “technically” worthless.
Recently, the group has caused a handful of companies’ stocks to spike, most notably GameStop.
Why GameStop?
One Wall Street Bets user made the case for the stock as a value investment, which means that this user viewed the stock as being more valuable than the stock price indicated. The case for buying a stock, the user wrote, had nothing to do with a turnaround in the video game retailer’s business, which has suffered during the pandemic.
So what happened to GameStop?
Many people bought into this logic. At the same time, a few hedge funds — professional investors with billions of dollars under management — were selling the stock short, betting it would go down.
So while short sellers were betting it would go down, the Wall Street Bets community started buying GameStop shares, taking the other side of the bet. In this tug of war, the stock price started to rise — and quickly. At least in this instance, the Reddit community proved to be more powerful than the short seller establishment.
[Read more: GameStop phenomena is about 'the poor vs rich': Reddit WSB user]
At the same time, the rise in the stock price put serious pressure on the short sellers.
Explain more about ‘shorting’ a stock.
Shorting means you sell the stock without actually owning it — you borrow it from a broker. Let’s say GameStop was trading at $10, but you thought it was going to go down to $5. You could borrow a share of GameStop, sell it to someone who wanted to buy it for $10, and wait. If the stock goes down to $5, you can close out the short by buying the stock for $5 at the market price and return it to the broker you borrowed it from, and you get a $5 profit.
But what if it goes up? That’s what happened here. If it went from $10 to $15, say, the broker you borrowed from might want to make sure you’re able to pay it back and ask for collateral, a “margin call.” That’s what’s happened with GameStop. An investor in that situation can also decide to cut their losses, and simply buy the stock for $15 and return it, closing out their position realizing a $5 loss in the process.
So far, GameStop shares have surged so much (they started the year at $17 and are at around $270 as of midday Wednesday) that it’s put these hedge funds into extreme financial distress as the losses mount.
Who is right about the value of GameStop?
It’s hard to say. But it doesn’t really matter. Economist John Maynard Keynes once said, “the markets can remain irrational longer than you can remain solvent.”
So even if Redditors are wrong and the stock eventually craters, it may have been up long enough to really hurt these hedge funds, causing losses of around 30% for one of them.
However, that hedge fund short-seller, Melvin Capital, just got a $2.75 billion bailout. It’s like in Casino Royale when James Bond is given another $5 million in chips by Felix Leiter to continue playing.
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Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.