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GameStop Corp. (GME) stock is over $300 at the time of this post. I understand the 10,000 foot view of the story only: That some Reddit folks are buying up shares to squeeze a short seller.

But I don't understand how this works. Why buy shares? Aren't they stuck with them when the bubble bursts? Seems like many of these people will be stuck holding shares when they come crashing back down.

I also saw a report of one Redditor who turned $50,000 into $22,000,000 using options of GME. Though this may be a separate question - how?

Chris W. Rea
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Paul
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    "Seems like many of these people will be stuck holding shares when they come crashing back down." Sure. It's a zero sum game and we know the short sellers will take huge losses. That sounds like a better than average deal for the non-short-sellers. – David Schwartz Jan 27 '21 at 23:59
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    Short sellers lose a lot when share price rises a lot (which is when the share owners make a lot of money). Conversely, long owners lose a lot when share price drops a lot (which is when the short sellers make a lot of money). Being stuck holding shares in a losing position only happens when you suffer from breakevenitis which can sometimes break you. – Bob Baerker Jan 28 '21 at 01:23
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    The short seller will be forced to buy the shares and transfer a lot of money to Reddit. Within Reddit, some Redditors will gain and some will lose. Reddit will win overall – user253751 Jan 28 '21 at 16:01
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    Unless Reddit is now a brokerage firm, no money will be transferred there. – Bob Baerker Jan 28 '21 at 16:18
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    Re "Aren't they stuck with them when the bubble bursts?" Of course, some people will be stuck with the shares they bought, but the people who started the bubble plan on not being the ones stuck. It's a fairly classic example of stock kiting - buying up or talking up shares in a company in order to cause an artifical price rise - adapted for the internet world. – jamesqf Jan 28 '21 at 17:33
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    OP, I'm not sure why you chose Bob Baerker's answer as accepted. Kaz's is much more understandable by my mother... – CGCampbell Jan 28 '21 at 17:33
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    @CGCampbell It was already accepted before I even got here. I came along. saw the Jargon, and decided a better explanation could be done. – Kaz Jan 28 '21 at 17:35
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    Note that this situation is a bit unique in that many of the Reddit investors used their recent covid stimulus money to do so. They saw that as free money that they wouldn't otherwise have, so they're less concerned about losing money than they would be if they invested part of their paycheck or savings. They still don't want to lose money, but they're more willing to trade a small loss for the satisfaction of seeing the hedge funds panic. – bta Jan 28 '21 at 17:49
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    I think that there's going to be a degree of speculation to any answer. There's only so much transparency we can have into what's going on. It's not like all people involved in this are posting on Reddit, or people posting on Reddit are posting a complete record of their transactions, or we can trust any statements about transactions people on Reddit claim. This smacks of a pump-and-dump scheme, and there are likely a lot of people being far from forth-coming as to what they're really doing. – Acccumulation Jan 28 '21 at 22:50
  • Yes, someone can! Unfortunately that someone is Margot Robbie in the bath, and she's busy. – Paul D. Waite Jan 29 '21 at 14:00
  • @CGCampbell You're absolutely right. But Kaz answer was almost 24 hours later and this question didn't get a lot of initial traffic. – Paul Jan 29 '21 at 14:08

6 Answers6

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You're a non-trader. So you maybe don't even 'get' what short-selling is intuitively yet. Let alone options. I'll try to make this as simple as possible.

Stocks first, options later:

Let's pretend we're not trading stocks, we're trading the latest Playstation 5 (seems appropriate).

If you think the price is going up then you buy a PS5 today, hold onto it, and hopefully sell it for a higher price in a few months.

If you think the price is going down, then you short-sell a PS5. Which goes like this:

You find a mate who already has a PS5. He's not really playing it right now. So he offers to lend it to you for £5 a week, as long as he can have it back as soon as he decides he doesn't want to lend it out anymore.

You sell the PS5 today for £500. And hope that it drops in value fast enough that when you have to buy it back, you'll have made a profit on the whole thing.

The key elements are that you have to borrow it from somebody who already has one, you have to pay them something (usually it's interest, not a fixed charge), and you have to buy it back later, sometimes without any say in when that happens. (Unlike with your actual mates, brokers and clearing houses aren't going to give you any leeway when they need to recall the shares).

Now if you sell too many like this, you might not be able to find enough to buy back when the time comes, and will be forced to pay whatever it takes to get them.

If somebody (In this case, people on reddit) notices that you've sold all these Playstations you don't have, they might decide to buy them all up first, to make sure that there are none left for you, and you have to pay an exorbitant price to buy them back.

This is a classic short squeeze. And usually you'll end up buying the Playstations back for 50%, 100%, 200% more than you sold them for just to get out of the trade.

That's bad enough. But now enter options:

Today, we're just going to talk about call options. A call option looks like this:

I pay you some amount of money for the option. In return, you promise to sell me 1,000 Playstations, for £2,000 each, at any point in the next 3 months, if I decide I want to buy them. (I have the option of buying them at a fixed price. Hence the name).

Back when Playstations were going for only £500 each, hedge funds would happily sell you that option for almost nothing, because there's no way the price is going to go that high in the next 3 months, so it's basically free money to them.

But then here's what happens:

They sell you a huge pile of options. In fact, they sell you options for half of all the Playstations in the world. Because there's no way they'll ever have to actually deliver them.

Then you start squeezing the stock. The price goes from £500 to £750. The hedge funds start getting a little nervous. £2,000 is still a long way away, but the price is already higher than they thought it would ever go. So they buy some Playstations just in case.

But buying more Playstations pushes up the price even further. Suddenly they're at £1,000 each. The hedge funds and the short sellers are starting to sweat a little. They buy more Playstations.

The price is pushed up even more. So they panic even more. And buy even more. If there's enough people buying because they sold the shares short. And enough people buying because they sold options they never thought would ever have to be fulfilled. And not enough Playstations to go around because the guys on the other end of this trade already bought them all, and all the options, and are holding them ransom.

Then there's nothing stopping the price going to infinity. (Or in this case, going up 2,000% and counting). *

The people who sold the options. When they buy a little bit to hedge. And then start buying more and more as the price gets closer to the point where they're on the hook. That whole thing is called Delta Hedging, and the amount they buy as the price changes is called Gamma (and hence this situation would be called a gamma squeeze). It's just "buying more of the thing you're on the hook for, the more likely it is that you'll actually have to deliver it".

Now to answer your questions:

Yes, if you buy the shares. And keep holding out for a higher price. You might miss the window as the whole thing comes crashing down again. Because it will crash eventually. Options will expire. People will decide to cash in and relieve the pressure. At a certain point, often quite suddenly, the whole thing will go into reverse and it'll be the people holding the options and stockpiling the Playstations who are desperate to dump them before the price crashes even further. Maybe you're the guy who buys the shares at $20 and sells them at $60. Maybe you're the guy who buys them at $60 and sells them at $300. And maybe you're the guy who buys them at $300 and sees them crash to $100 only an hour later. **

As for the $50,000. That was a guy who bought those options for pennies on the dollar. Basically the funds went "Yeah, sure, Playstations at £2,000 each within 3 months. Never gonna happen. We'll offer you 200:1 odds on that". He bought them, it happened, and now he can cash it in for a massive payout.

The way that actually works is that the option is for 1,000 Playsations at £2,000 each. And they sell the option to you for £2,500 total (£2.50 per potential Playstation). So you buy 20 options for £50k.

They're worthless if the price is less than £2,000. But if the price is now £3,000 per Playstation (IE your £2.50 per console is now worth a cool £1,000 per console). Then they're worth 1,000 Playstations * £1000 * 20 options = £20 Million, for a 400x return.

* There are, actually, lots of things that will eventually stop it going to infinity. If not people selling of their own accord, then brokers or regulators will eventually step in and put a halt to things. In this case, brokers just stopped most retail traders from being allowed to buy new shares/options, which stops the squeeze and starts the rush to the exits.

** Like, say, today. 28th January 2021. Where GME opened at £263 per share. Almost doubled in the space of 30 minutes to £469 per share and in the 90 minutes since has dropped 75%.

If you enjoy entertaining and informative explanations of what the hell is going on in finance today, you should read everything Matt Levine has ever published. Including the last 4 days' coverage of GameStop.

Kaz
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    +1 ... Nice non trader analogy. – Bob Baerker Jan 28 '21 at 12:50
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    In your final point of $20,000,000 profit are you selling the options themselves back to who sold them to you for the difference or do you need to pony up the $40,000,000 and sell them for $60,000,000 to get that profit? – Warcupine Jan 28 '21 at 16:41
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    @Warcupine You can, in theory, do either. In practice, there are firms out there that specialise in buying options for slightly less than they're worth, and then doing the hard work of ponying up the money, buying/selling the resulting stock or selling other options to net it all out. In practice, you can assume that you'll be able to sell an option for roughly what it's intrinsically worth. Or maybe more if it has a decent time to expiry still left on it. – Kaz Jan 28 '21 at 16:46
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    @Warcupine - You can always sell the options in the option market but when they are that valuable, you'll most likely be unable to get their full value (intrinsic value) unless the implied volatility is sky high as it is with GME. How to achieve the full value involves ponying up the money but that is a technical answer not likely to go over well here. – Bob Baerker Jan 28 '21 at 17:44
  • @Kaz all of that makes sense to me except for this bit: and you have to buy it back later, sometimes without any say in when that happens. What is it that's forcing the hedgefund to buy it back now, rather than just waiting for the whole thing to blow over. In you (excellent!) analogy who is the hedgefund's mate with a PS5, and what's his incentive to say "no I do actually want that PS5 back", rather than say "oh, is it inconvenient to return it now? Well ... I wasn't actually go to play with it tonight either, so just keep it another week."? – Brondahl Jan 28 '21 at 18:57
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    @Brondahl In simple terms: There are very strictly enforced rules and regulations that say you're not allowed to fudge it. If the person wants their stock back, you have to either find somebody else to borrow it off or buy it back for them pretty much then and there. (In reality, you don't do that yourself, your broker aggregates the sourcing and lending of shares. So they're the ones who find them for you to borrow. And they're the ones who give you the call to say they're being recalled and you have 24 hours to find a new source or buy them back). – Kaz Jan 28 '21 at 19:59
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    @RonJohn I would agree with you if these days "overvalued" or "undervalued" would not be a synonym of "this does not match my investment strategy" of a small elite. – Yanick Salzmann Jan 28 '21 at 20:48
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    @YanickSalzmann your assertions are left-wing populism just as much as Trump is right-wing populism. – RonJohn Jan 28 '21 at 21:19
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    @YanickSalzmann and both are just as wrong. – RonJohn Jan 28 '21 at 21:19
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    They used to be until today, lol – Yanick Salzmann Jan 28 '21 at 21:19
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    @JSLavertu what's your point? From a populist point of view, "saving the little guy from rapacious Wall Street monsters" (which is what the lock-out does: prevents a bunch of inexperienced noobs from losing more money). It's like the life guard telling all the young kids who can barely swim to get out of the deep end of the pool, and then barricade it off. – RonJohn Jan 29 '21 at 00:15
  • @JSLavertu you think you know about Melvin. What about the Little Guys taking a bath? – RonJohn Jan 29 '21 at 00:31
  • @JSLavertu explain to me why "little guys taking a bath" is insanely condescending. – RonJohn Jan 29 '21 at 01:06
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    @RonJohn just curious : do you consider finance to have been a broken system in 2008? CDOs, subprimes, worthless AAA ratings,,,? If yes, did it change much since then? – Eric Duminil Jan 29 '21 at 03:43
  • @EricDuminil that's off-topic to this conversation. – RonJohn Jan 29 '21 at 03:46
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    @RonJohn right. How are examples of a broken system when talking about the broken system off-topic? – Eric Duminil Jan 29 '21 at 03:51
  • @EricDuminil consider a broken house: you ask diy.SE about your broken heater (installed by an incompetent contractor), but someone intrudes about your roof that broke 12 years ago due to contractor corruption. It's off-topic to the question about the broken heater. You might even still be mad about the roof, but... it's off-topic when asking about the heater. – RonJohn Jan 29 '21 at 04:03
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    @JS Lavertu: It is actually fairly common for trading in particular stocks to be halted. https://www.investopedia.com/terms/s/suspended_trading.asp In this case, it seems quite possible that there's a stock kiting scheme here, which I think (I'm not a lawyer, though) would be criminal. – jamesqf Jan 29 '21 at 05:57
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    @RonJohn I'd rather describe it as a shaky foundation of the house, which causes problem for both the heater and the roof. But that probably sounds like left-wing populism to you. – Eric Duminil Jan 29 '21 at 09:57
  • @Brondahl You're right, actually, there isn't much incentive for someone to recall what they've loaned out (unless they want to sell it!). And if they did, you could probably find someone else to borrow from. The issue is partially hidden in the parenthetical "(usually it's interest, not a fixed charge)" - the cost to borrow is typically a percentage of the thing's current price, rather than a fixed amount. Since the price went up 17x or so, the daily borrow cost did as well. Pricey! – Aaron Dufour Jan 29 '21 at 12:04
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    @Brondahl The other part is, the person who you borrowed from might not trust you to return the stock when they ask. So they make you "post collateral" - that is, put some money (or stocks) somewhere they can pull from if you fail to return their stock when they ask. Before, the price was $20, and it was pretty stable, so collateral might be $20. Now the price is $350, but it is also moving around a lot, so there's a good chance it might be $700 when they want it back, or $1000. So instead of collateral going up by a mere 17x, maybe they increase it by more like 50x. – Aaron Dufour Jan 29 '21 at 12:05
  • @AaronDufour Yeah. It's usually not "they're recalling the stock" but "they've sold the stock to somebody else, at a different broker. so we have to send the stock over. That broker may well go and lend it out in the market, but not to us". And collateral would usually be a fraction of the stock (IE if you short $1,000, they might have you keep at least $300 as collateral) which may well be raised to a higher fraction, if not 100% )of the new value), if it's exceptionally volatile. – Kaz Jan 29 '21 at 12:55
  • @JSLavertu I'm... more than a little stunned that you're ignoring all the apparatus set up by the government to protect The Little Guy. Let's start with the Consumer Financial Protection Bureau. – RonJohn Jan 29 '21 at 13:48
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    @RonJohn And sure, preventing someone from buying those stocks on margin makes sense to a broker at this point; volatility is too high, and it is the broker who might be left holding the bag if you can't make your margin call on it. But when the broker is changing the rules to help their big clients unwind their positions against a distributed attack on those positions, they are not acting in the interests of all of their clients, but rather some of them. And it is a pretty big coincidence that "you can only take short positions" kicks off in the middle of such an attack. – Yakk Jan 29 '21 at 14:52
  • @JSLavertu https://i.dailymail.co.uk/1s/2021/01/29/09/38609710-9199575-Robinhood_began_forcibly_close_certain_stock_positions_if_they_w-a-14_1611912044265.jpg note the phrase "unreasonable risk". Brokers are highly regulated; I bet there's something in the SEC regs about this. – RonJohn Jan 29 '21 at 16:00
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Short sellers borrow shares that they believe will drop in price in order to buy them back after they fall. If they're wrong, they're forced to buy at a higher price, incurring a loss.

More than 100% of GME stock was shorted by traders and investment funds. Redditors drove the price up, forcing these shorters to buy the stock to cover their losses.

Another factor in this is what's called a gamma squeeze. When traders buy options, if the counter party is a market maker, the market maker offsets the risk by taking a position in the stock. Redditors have been buying large numbers of calls.

As an example, an at-the-money call has a delta of about 0.50. So for every ATM call that the market maker sells, he buys 50 shares to hedge the delta risk.

Gamma is the rate of change of the Delta. As the stock begins to rise, the market maker needs to buy more shares as delta and gamma rise. This adds fuel to the short squeeze fire.

Now as share price continues to rise, many shorters cover their short positions. That means more buying of the stock, further increasing prices.

A good description of all of the combination of all of these factors would be a chain reaction where share price literally blows up.

As for getting stuck with shares, that happens to everyone in the market who owns stock when the stock drops (see last March when the market dropped 35%). GME has gone from about $20 to over $350 in a couple of weeks. That's not a bad problem to have if you bought early and it is easily fixed. However, you could become a bag holder if you bought near the top. Yesterday the top was around $160. Today, so far it's been around $352. But when will the top finally occur? Today? Tomorrow? Even later?

spacetyper
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Bob Baerker
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    As bizarre as it may sound, there is a kernel of fundamentals behind this as well: GameStop was probably over-shorted and under-valued before this whole mess began. It's not like they have a huge pile of leveraged buyout debt or something toxic like that on their balance sheet, they now have Ryan Cohen (who is not a magician, of course, but at least he's the right kind of person to do a turnaround), and the next generation of consoles will be hitting store shelves in the near future. On the other hand, it's not entirely obvious to me that the digital market has a niche for them. – Kevin Jan 28 '21 at 02:25
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    While there may have been some fundamental undervalue to GameStop, a jump from $20 less than a month ago to $380 is all about a short squeeze. – Bob Baerker Jan 28 '21 at 04:29
  • Of course I agree that $380 is nowhere near its fundamental value. If shorts and derivatives didn't exist, this would not be a story. – Kevin Jan 28 '21 at 06:27
  • The fundamentals are not really good, even for 20$ per share. Selling games in a mall is a concept under pressure. Selling games on the internet may help with this but this is already an established market and what can they offer that others (Amazon, Steam, etc) do not? – Manziel Jan 28 '21 at 08:09
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    "When traders buy options, if the counter party is a market maker, the market maker offsets the risk by taking a position in the stock. Redditors have been buying large numbers of calls." - As a non-trader, these sentences are completely indecipherable to me. In fact, the entire rest of the answer consists exclusively of unexplained jargon. -1 from me. – BlueRaja - Danny Pflughoeft Jan 28 '21 at 09:58
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    @BobBaerker I think BlueRaja downvoted because the jargon doesn't answer this "to a non-stock trader" like the question asks. I can't speak to this because I'm fairly financially literate, but I would take their comment in good faith (it's really not hard to say what delta and gamma mean) – Steve Cox Jan 28 '21 at 13:23
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    This answer is undecipherable as a layman – Behacad Jan 28 '21 at 15:43
  • "More than 100% of GME stock was shorted by traders and investment funds." Does that mean that there were shares that were bought, loaned to a short seller who then sold them to someone who then loaned to another short seller who sold the share yet again? That is, there are multiple short sales back by the same share of stock? – Acccumulation Jan 28 '21 at 22:53
  • @Acccumulation That is absolutely a thing that is possible. In this case though, I believe it's a misinterpretation, and it should be "more than 100% of the float". The float is a much smaller share of the company, and is measuring how many of its shares are actually available to be bought and sold. 'floating around the exchanges', as it were. Often big chunks of companies are owned by founders, executives, strategic investors etc. who aren't going to buy or sell anytime soon, So there are few fewer shares available to be bought/sold than there are in the company as a whole. – Kaz Jan 28 '21 at 23:13
  • As a non-trader, these sentences are completely indecipherable to me. In fact, the entire rest of the answer consists exclusively of unexplained jargon. If you don't understand something, sometimes you have to make an effort to learn what more complex things mean. That may include looking jargon up or asking questions for further details. This is one of those times. – Bob Baerker Apr 10 '22 at 14:59
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One interesting aspect to this situation that I think is under-discussed is

  • Why don't the shorts just wait for the squeeze to end?

After all, GME is practically worthless; in 2022, the value of GME is more likely to be 10$ than 100$. If you have shorted GME and you just wait until 2022 to give it back, you won't be out any money at all.

Unfortunately for you, shorts can closed out at any time by the lender. So rather than thinking of a short as being a bet that a stock will go down in the future, you must think of a short as being a bet that a stock will never increase above its current price before you decide to buy it back. Because if it did increase, the lender could demand it back immediately, and regardless of its long-term prospects, you lose money.

A put is a similar investment with a fixed time horizon that avoids this risk, but of course has its own disadvantages.

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    In practice, forced closing of shorts seems pretty rare, and it hasn't happened much in this instance as far as I know. If the lender doesn't force you to close, you can wait as long as you want - most short sellers are voluntarily closing their positions. The bigger issue, I think, is the fees - for every day you have the short position, you owe interest to whomever you borrowed the share from. Even if you can keep your short position open for a long time, it's guaranteeing that you'll pay interest with no guarantee that the situation will be any better after a month or a year. – Nuclear Hoagie Jan 28 '21 at 15:34
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    ...the lender could demand it back immediately. That's not exactly true. Suppose you're short GME and the lender sells his stock. Your broker will attempt to find replacement shares. If he does, you can remain short. If he cannot, you must cover your short. If you don't, your broker will do so. The other reason that you cannot keep a short position open indefinitely is the minimum margin requirement. For Reg T shorts it's 50% initial and 30% maintenance. So the threshold is the credit (short proceeds + initial margin). IOW, put up $5k, short $10k and $1,538 is where you get into trouble. – Bob Baerker Jan 28 '21 at 15:42
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    @Nuclear Hoagie - Your impression is incorrect. A shorter cannot wait as long as he wants to close the position. Shorters must maintain the Reg T minimum margin requirement of 30% (unless the broker requires higher margin protection). If they do not, the broker will immediately close the position. Last I looked, the borrow rate for GME was 37% which is high for normal stocks but quite low for circumstances like this. When Tilray soared from $20 to $150 in a month or so two years ago, its borrow rate was over 900%. – Bob Baerker Jan 28 '21 at 15:49
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    @BobBaerker Thanks, I'm learning a lot of new terms this week. Can a shorter add cash to their margin account to keep above the minimum margin requirement? I'm wondering if closing a short due to margin requirements is a decision internal to the shorter (do I want to add money in the margin account?) or if it's purely external (you can't add more money and must close if the price goes too high). – Nuclear Hoagie Jan 28 '21 at 15:57
  • @NuclearHoagie. I am sure it depends on the broker. The one I used all accepted that you top up your margin account, but there may be brokers less flexible out there. If you deal in these kind of market, that's an information you must definitely have before you start, you don't want to learn this kind of surprise when your margin is already plumetting. – Hoki Jan 28 '21 at 16:01
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    @NuclearHoagie - A shorter can increase his margin by depositing cash or marginable securities to his account. If you shorted 100 shares of GME at $20, you'd need $1k to meet initial margin. Now GME rises to $350. If I did my margin calculation correctly (often questionable), you'd need another $26k along the way to keep the position open. OUCH! – Bob Baerker Jan 28 '21 at 16:14
  • @BobBaerker These are good points I was hoping not to discuss to keep things simple. Do you think the details make the answer too misleading? I should probably add a mention of minimum margin if we think that's the main thing driving the closing of shorts. If it's just the shuffling done by the broker, I think eliding the details is ok. – Xerxes Jan 28 '21 at 16:49
  • @Xerxes - It's OK if additional details or clarifications are added in the comment section. If you feel that editing would improve your answer, do so. But I wouldn't fret about writing the perfect answer. If you stoick around, in time, you'll find your own comfort zone. Up and down votes will provide some feedback. And remember, no matter how many people downvote you, you still get to walk around in your underwear at home ;->) – Bob Baerker Jan 28 '21 at 16:59
  • @BobBaerker One question I have: Does minimum margin actually apply to these huge hedge funds with millions in exposure? Why would a prime broker want to hurt a client by forcing them to close shorts during a squeeze? – Xerxes Jan 28 '21 at 17:05
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    @Xerxes - That's a good question which I do not know the answer to. I know that market makers have very low margin requirements but I don't know about hedge funds. A prime broker doesn't want to hurt a client by forcing them to close shorts during a squeeze. In the US, margin is governed by Reg T. Initial margin is 50% and the minimum maintenance requirement (MMR )is 25% for long and 30% for short (higher for leveraged securities). Brokers can impose stricter margin requirements. Violating the MMR requires the forced buy in of a short, protecting both the client and the broker. – Bob Baerker Jan 28 '21 at 17:12
6

This is one of those things that comes around sometimes in the market and is the number 1 risk of shorting stocks - a short squeeze.

To recap really quick as others have already stated, shorting a stock is where you borrow it from someone else, sell it in the market and then hope to buy it back at a lower price later thus making profit: Borrow at 10, sell at 10, price goes down to 5, you buy it back in the market and return it to where your borrowed from. Profit 5. The questions here are usually why would someone lend you a stock you knowing you are trying to make it go down? Well, big investors like pension funds will hold a stock for years if it is in their index so they're happy to make a bit of extra money lending it out to you.

The biggest risk of shorting a stock is that the price goes up by so much that your broker asks you to post more collateral in your account (a margin call). If you can't or won't, then you have to buy it back in the market at a loss. This buying then adds to the upwards pressure on the stock, pushing the price higher.

In the short term, stock returns are all about supply and demand. If i don't want to sell and you really want to buy then i can ask for a higher price for the stock. In a short squeeze, lots of people that had borrowed shares now have to go and buy them back in the market at the same time thus increasing demand and pushing the price of the shares up.

A good primer into what happened with GME is back in 2009 when VW was being heavily shorted when its biggest shareholder, Porsche, announced to the market that it actually owned many more shares than it had previously reported. This meant that the number of shares being borrowed (the short interest) was more than the number of shares available (this is important). Essentially, supply completely dried up and brokers demanded more money on margin accounts which pushed the price of VW up dramatically to where for about 15 minutes VW was the largest company in the world by market cap!

On to GME. GME has for quite some time been a favorite of short sellers that have been expecting it to go bankrupt due to it being a brick and mortar retailer. A guy on reddit, for the past year has been trying to highlight to people on r/Wallstreebets that the short interest was so high that the company was susceptible to a short squeeze. Last week, he finally saw an opening.

He saw that the January call option expiry was coming up and the Gamma was very low, Gamma being a measure of an options volatility and essential to the calculations that brokers/market makers use to calculate how many shares they have to have on hand to cover the option's collateral. His argument was that if everyone bought these call options then it would require the market makes to go out and buy more shares, the slight rise in share price that would accompany this (and normally nothing to worry about) would mean that more shares would need to be bought as the low gamma would increase thus creating a kind of multiplying effect and a feedback loop. The more the people bought the calls, the more shares the market makers would need to buy, the higher the gamma would go, the more shares the market makers would need to buy and so on.

In normal conditions, a deep liquid market would have no problem absorbing this buying and your OTM calls would expire worthless, losing you money. However, as around 160% of the total shares were committed to being lent out to short sellers this was not a deep and liquid market. He got the feedback loop he wanted and a mega short squeeze. Once others saw what was happening they jumped on the bandwagon, pushing the price up to crazy levels.

As to your two specific questions:

Will people get left holding the bag? Yes. Always the case as shares are zero sum. Now, are these new people coming in or the original people that started it? Who knows.

How did one guy make 22m from 15k? Out of the money (OTM) options. They have a huge amount of leverage in them as they allow you to buy a large number of shares for pennies on the dollar at a fixed price, especially as they were due to expire in a few days.

Johnny Bravo
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  • This is a very thorough answer that may get lost among all of the others. As to the question of: ...why would someone lend you a stock you knowing you are trying to make it go down?, when people open a margin account, they sign a hypothecation agreement which allows their shares to be loaned out (unless you sign a Loan Exempt Restriction). – Bob Baerker Jan 29 '21 at 14:07
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Simply put: short sellers are betting a lot of money against the stock. If they lose that bet, someone has to win - the money has to go somewhere. As they cannot hold the bet forever, it is possible (not necessary!) that they lose.

If they lose, someone else has to win. If they lose big, someone else wins big.

In reality, a lot of people will lose big and a lot of people will win big.

DonQuiKong
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    Addition: the hope that everyone apart from short sellers wins because they short sellers will buy all the shares at high prices is... Optimistic at best in myopinion (it's an option which is why I'm just commenting). – DonQuiKong Jan 27 '21 at 19:06
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    What particularly interesting about a short sale is that the losses are theoretically unlimited. If you buy $20 worth of stock, you can only lose that $20 and no more. A stock can't fall by more than it's worth, but there's no limit to how high a stock can climb - as the stock climbs higher and higher, short sellers lose more and more. Short sales can result in really big losses. – Nuclear Hoagie Jan 27 '21 at 20:04
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    Which is why brokers will force short sellers to cover their positions at some point, adding the interesting twist to the whole thing – Manziel Jan 27 '21 at 20:08
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    @DonQuiKong The more realistic position is that short sellers will take large losses and the rest of the gains and losses will be apportioned among everyone else for a net zero sum. Thus it makes sense to be in the "not a short seller" group as that group has a net gain, even though it is still quite risky. The short sellers were saying "we're willing to take large losses if this stock goes up", making it very rational to be in a zero sum game with them. – David Schwartz Jan 27 '21 at 23:58
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    More specifically, in the case of these options, the game ends on Friday, January 29, at 4pm ET. – chrylis -cautiouslyoptimistic- Jan 28 '21 at 04:54
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    Existing option positions can be rolled to any of the next 5 weekly option expirations. New positions can be opened as well. And there are 6 monthly expirations available as well. Game over on Friday 1/29? No, not at all. The upside game is over when enough pounds of flesh have been extracted from the shorts if/when they capitulate. – Bob Baerker Jan 28 '21 at 05:19
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Gamestop was shorted to over 130% of its shares. As the price rises the hedge funds who hold the short interest must at some stage settle their position. This means they have to buy 1 share for every share they have shorted. As the price rises the cost of them exiting their position rises exponentially. As there are few shares available the demand far exceeds the supply. The price MUST go up. This is the squeeze. In theory it can go to infinity. At some stage shareholders will cash in and the share price will crash. This is clearly understood, but one of the aims is go give pain to the hedge funds. It will result in a significant redistribrution of wealth from hedge funds to retail investors. Many shareholders are prepared to lose 100% in order to punish the large hedge funds (seen as the elite Wall Street suits)

chrisk
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  • That was covered pretty well by Kaz, but how can you short 130% if you have to borrow those shares to pre-sell them? – Paul Jan 29 '21 at 14:34
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    @paul Person A has 10 shares. They loan them to B. B sells them to C. So we have: A owns 10. B owns -10, C owns 10. But C can loan them to D. Who sells them to E. who loans them to F, who sells them to G. Now we have A, C, F, G all 'owning' 10 shares. And B, D, F all with -10. So there's still only 10 shares, but -30 short and +40 long. – Kaz Jan 31 '21 at 00:16
  • @Kaz OMG. Thanks for the explanation. Good thing that it's all supposedly very regulated. – Eric Duminil Jan 31 '21 at 09:19