But /r/WallStreetBets has a Plan — a Plan which doesn’t rely on there being a greater fool to buy at a higher price. I was quite surprised, when I first looked into the affair yesterday — surprised enough that I ended up writing this article despite having no specialist expertise or credentials. No, I’m not buying or selling Gamestop, and I won’t be recommending that you do so. I’m writing this because a certain feature of the affair is one I find interesting. On my home planet it would be front-page news, but the media here has other priorities; it hasn’t reported at all the interesting part, anywhere that I’ve read.
So what’s this Plan about? Roughly, it’s to engineer a short squeeze on Gamestop, but with a historically unprecedented twist. No, I can’t just tell you the twist right this minute and stop wasting your time. It legitimately takes some background to explain, unless you’re starting out understanding more than I did. In principle, one could deduce it just from having heard “/r/WallStreetBets has a plan to engineer a short squeeze on Gamestop”; but I had to be walked through several steps myself before I realized.
Sometimes, when you think you’re holding a stock in your account — say, GlomCo stock, for the sake of concreteness — your broker isn’t really holding all the shares of that stock. What your broker did instead, was charge somebody else to borrow some of the GlomCo shares it’s theoretically holding on behalf of end-consumers like you; then the borrower sells the GlomCo stock with intent to buy it back later and repay the loan. Key detail: whoever buys this stock may then have their broker quietly loan it out again in turn, behind the scenes.
Or more concretely, Alice buys 100 shares of GlomCo and holds them at Charles Schwab. Charles Schwab quietly loans those 100 shares to Bob, who short-sells them to Carol, who holds her shares at Fidelity, which quietly loans out 100 shares to Dennis, who sells them to Eileen. If you imagine that GlomCo only had 100 shares in the first place, then at the end of this operation there is “200% short interest outstanding” in GlomCo: Bob and Dennis have collectively borrowed-and-sold (and now owe back) 200 shares of GlomCo, or 2X as much as actually exists. That’s without “naked shorting” or selling synthetic copies of a stock.
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The last I heard, Gamestop had 130% short interest outstanding. That is, short-sellers have collectively borrowed, and now collectively owe, 130% as much Gamestop stock as exists anywhere.
This happens, from time to time, in stock markets. When it does, it creates an opportunity for hedge funds to make a daring play. If a hedge fund can buy up enough of the company stock themselves, they can hold enough that the short-sellers have to go to the hedge fund to buy back the stock.
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Cases surprisingly close to that have actually happened. In one of the legendary cases, Volkswagen was very heavily shorted, and Porsche announced it had bought up over 74% of Volkswagen… while around 55% of Volkswagen shares were held by index funds, effectively unavailable for trading at any price. That these two numbers sum to over 100% is not an error. Prices of Volkswagen shares spiked to where Volkswagen was briefly the most expensive company in the world. Or for another example, Martin Shkreli once engineered a 10,000% price rise via short squeeze on a small company called KalaBios. It’s not just a weird hypothetical theory; it has actually worked and people have collected huge profits on it.
This is what /r/WallStreetBets is trying to do with Gamestop — buy up enough of Gamestop themselves that there’s not enough other Gamestop shares left, on the broader market, to pay back the 130% outstanding shorts. If it works, it forces the short sellers to buy back some shares at whatever price /r/WallStreetBets decides to charge. The stock price is swinging as I revise this; when I wrote the first draft, as of Wednesday’s close the stock price was at $347, for a market cap of $24 billion. Gamestop was under $5 one year ago.
But so far as I know, this scheme has never before been successfully carried out by a large group of retail investors instead of a hedge fund. And there’s a fundamental reason for that! A group of retail investors face a technically interesting coordination problem in trying to engineer a short squeeze, a problem that one monolithic hedge fund does not face. So I will be really interested if /r/WallStreetBets pulls it off successfully, or even mostly successfully.
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What most mainstream coverage I’ve seen, tries to insinuate is going on, is that /r/WallStreetBets is just a horde of suckers on the Internet, trying to buy up enough of some random company that the stock price skyrockets, hoping they’ll all get rich. From reading mainstream coverage, I didn’t realize there was a Plan beyond this; until I mentioned the issue on Twitter, and some more knowledgeable people graciously corrected me. But indeed, if that were all that was happening, it would be a classic “pump” scheme; which can’t generate net profits for all of the buyers, because the buyers are playing a zero-sum game among themselves.
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If too many of them try to sell all their shares back, when the price goes astronomical— then the very very earliest sellers may make a vast profit. But the share price will start dropping fast, and only the earliest sellers will get Lambos.
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If too many people defect and sell 100% right away, the scheme collapses. The stock price may drop precipitously if it looks like that might be starting to happen; and then the scheme is only repairable if that causes enough of /r/WallStreetBets to lock up, hunker down, and wait for the price to go back up again. If instead it panics a large-enough fraction of squeezers into selling 100%, the whole scheme is over.
This is why short squeezes are usually engineered by a monolithic hedge fund — it doesn’t face the same coordination problems internally.
For a hundred thousand people to do the same would be unprecedented! I don’t just mean that the particular scheme of short-squeezing is unprecedented; I mean that I’ve never heard of human beings successfully solving a coordination problem built out of thousands of strangers, with big financial payouts for early defection and zero ability to enforce against defection.