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According to

the subreddit r/wallstreetbets is buying, en masse, stocks that are being shorted by institutional investors. How does this benefit the members of r/wallstreetbets?

Once they decided to move onto another stock them all selling, at the same time, will mean they'll all stand to lose a lot of money, i.e., they won't be able to sell the shares for what they paid for them.

If it was a bunch of people with a high disposable income who were willing to throw away $100 / each to "stick it to the man", that'd be one thing as it's not monetary gain they're looking for, anyway. But if that's what it is then it seems to me that the problem will eventually self correct as the /r/wallstreetbets/ community eventually runs out of money?

Rodrigo de Azevedo
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neubert
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    In addition to what Franck Dernoncourt said, there is some motivation beyond pure profits. A lot of people hate wall street and find the schadenfreude of seeing them suffer worth losing their entire investment. – Ryan_L Jan 28 '21 at 22:16
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    @Ryan_L which then reinforces their belief in "powers beyond their control". – RonJohn Jan 28 '21 at 23:46
  • A company at risk of bankruptcy can't have its stock used as a cryptocurrency. The stock will be dissolved in either a reorganization or a liquidation. Now some of the short sellers may just be bond holders with ill-liquid bonds. – S Spring Jan 28 '21 at 23:46
  • @SSpring As far as they are saying, Gamestop isn't really at risk of bankruptcy, it's not doing well but it's not in massive debt or anything either. – user253751 Jan 29 '21 at 18:18
  • Well, go to marketwatch-dot-com and read the year 2020 balance sheet for GME. – S Spring Jan 29 '21 at 20:01
  • @SSpring "can't have its stock used as a cryptocurrency"... this collection of words doesn't make any sense to me! –  Jan 30 '21 at 20:42
  • That's a suggestive viewpoint of what the squeezers are doing. They think they can drive and hold any valuation without regard to fundamentals. For instance the company has negative cash-flow and a debt-to-equity ratio of 194. – S Spring Jan 30 '21 at 20:57

6 Answers6

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The idea is that WSB members will buy up a bunch of the stock, which will raise the price of the stock. Short sellers will then buy up stock to cover their positions, and they'll have to buy those shares at the higher price. This will raise the price even more, then WSB members will sell their stock at this higher price. This sell off will then create a crash. If it goes as planned, there will be a net transfer of money from short sellers to WSB members. But this money will not be evenly distributed; those who bought in early and sold right before the crash will make the most, while those who bought later, or sold after the crash, will make less, or even lose money.

Basically, this is very much like a pyramid scheme, except that with a normal pyramid scheme, there is no outside source of money, so once the transaction costs are included, there's a net loss of money over all the participants. With WSB, on the other hand, the idea is to force short sellers to be the bottom of the pyramid, so that it's possible for the rest of the pyramid to make a net profit. With short-selling, you're essentially selling the stock before you're buying it. Or, in terms of a pyramid scheme, short sellers are cashing out of the pyramid scheme first, and then are forced later to buy into the scheme.

Imagine it's 2007 and you're trying to decide whether to invest in Bernie Madoff's "investment fund". You know it's a Ponzi scheme, but you also know that there are a bunch of people that have promised to "invest" money into the scheme. So you decide to put your money in, figuring that as long as Madoff has money from those other investors coming in, he'll keep running the fund. That's sort of what this is like, except not as illegal (probably).

Acccumulation
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how does this benefit the members of the /r/wallstreetbets/ ?

To simplify:

  1. Institutional investors short stock A
  2. Massive purchase from WSB of stock A
  3. WSB members (on average) profit during the subsequent short squeeze.
Franck Dernoncourt
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    basically a net transfer from short sellers to buyers. But note that it doesn't mean every buyer got money! (Feel free to buy in now, but treat it as a donation to stop Big Finance, not an investment. Your money will probably end up in WSB) – user253751 Jan 28 '21 at 22:47
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    @user253751 yes, e.g. WSB -> loss flair. – Franck Dernoncourt Jan 28 '21 at 22:51
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    I nearly got this... Could you describe a bit what each step means? I understand 1) means; institutional investors borrow stock A (from, e.g. pension fund portfolios), sell it immediately, hoping to buy it back later at a lower price to return to the lender. But I don't know what a short squeeze is. – Oscar Bravo Jan 29 '21 at 07:15
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    @OscarBravo done – Franck Dernoncourt Jan 29 '21 at 07:17
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    @OscarBravo: You know for a fact that the institutional investors have to buy back that stock they sold. So what you do is buy all of that stock (or most of it). In this case, many "normal" people banded together to act as one big "flash mob hedge fund" to be able to jointly buy the stock. And then you raise the price you'd sell it for, because you know the short sellers will have to come buy it. As long as you own enough of the stock that the institutional investors can't avoid you (or your prices), they are effectively forced to buy the stock from you due to their prior obligations. – Flater Jan 29 '21 at 11:01
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    This is a probably a great simplification for people who already know what shorts are and how they work. For most readers though, it might as well be Greek, even with the link to a short squeeze Wikipedia article. Indeed, even to fully understand a short squeeze, I have to click through to yet another link to read about what 'covering positions' means. – TylerH Jan 29 '21 at 16:22
  • @TylerH Greeks are for options – Franck Dernoncourt Jan 29 '21 at 16:55
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    I think this answer could be improved by further elaborating on what it means that r/wsb "on average" profits. That is - those who got in early at <$50 a share will rake in massive profits, a few others who manage to avoid the incoming crash will profit some, and it is quite likely that the majority of redditors will lose massively, effectively offering their own cash as grease to profit the wheels operated by the early adopters who pushed the hardest for adoption. – Grade 'Eh' Bacon Jan 29 '21 at 17:42
  • There are other questions/answers on money.SE which go into more depth. E.g., https://money.stackexchange.com/a/135469/71414 – Brian Jan 29 '21 at 19:35
  • @Flater Aha... so the flash mob bought up tons of stock then put it back into the market with a high Ask Price (not the usual Market Price), thus forcing the Shorters (who were contractually obligated to buy) to match their price. Clever... – Oscar Bravo Feb 01 '21 at 08:05
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    As explained by Franck, it really is that simple. Anyone who bought GME anywhere from $20 and up over $400 made money as long as they sold. A massive amount of money was distributed from short sellers to such buyers during the short squeeze rise to $500. All of these comments by others about about all of the losers miss this point. Since WSB was early, they had to make money on average. And when the squeeze is over, the process repeats itself and reverses except that the bag holders now get whupped. – Bob Baerker Mar 02 '21 at 22:25
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From what I understood about the news coverage regarding this, was that the WallstreetBet community was not only/primarily interested in gaining money from this scheme but also/rather inflicting loss on the hedge funds who shorted GameStop. So apart from possible monetary gains, the WallstreetBet community gets the psychologically reward of teaching big finance a lesson. Or at least that's what they are pretending.

thieupepijn
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    I take issue with that last word. How is costing the hedge funds an estimated $2b so far "pretending"? – Adam Barnes Jan 29 '21 at 12:38
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    The idea that they did it to help the SEC and Wall St beat up on a hedge fund, is hilarious. – Fattie Jan 29 '21 at 13:50
  • @Fattie More like they did it to beat up a hedge fund, and Wall St may or may not have jumped in (maybe, maybe not, it's an irrationally bad bet so you'd hope not). As for the SEC, they have nothing to do with WSB here, or the original hedge fund, but they may be angry at the brokers that locked WSB out of trading to protect the hedge fund... – user253751 Jan 29 '21 at 18:21
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    @AdamBarnes The leaders of this short squeeze can make millions while a lot of the followers are going to lose a lot of money. So the implication I take from this is that, it we take the cynical view, the pretense of 'sticking it to the man' is a way to trick fools into pissing away their money to execute the scheme. I don't really know but I'm having trouble making a clear distinction between this and your run-of-the-mill pump and dump scheme. – JimmyJames Jan 29 '21 at 19:30
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    @JimmyJames: it's a pump and dump if you give the other investors bad information. If you publically say, "hey, I think $300 is a price we can realistically squeeze to", and you bail out at $300 as promised, and other new investors (not just the shorters) are still piling in at $350, then it it might be some other form of price manipulation but I don't think it's a pump and dump and you never advised those people to buy. OTOH if you publically say $1000 and bail at $300, that's starting to look shady to me. But I'm not the SEC, a fact for which everyone is grateful. – Steve Jessop Jan 29 '21 at 20:15
  • @SteveJessop That makes sense. There's something off about the idea of a group of people deciding to manipulate the price of a stock. I'm not crying for the hedge funds. They oversold and got caught with their pants down. They should have known the risks. I just wonder what this means in the larger context of the market. – JimmyJames Jan 29 '21 at 20:34
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    And to be fair, the hedge funds are also manipulating the price of the stock. Typically within whatever rules pertain at the time. OK the stock didn't go where Melvin Capital wanted it to, but short-sellers collectively are pushing the price in the direction they're betting it will go, just as much as long-buyers are in the other direction. – Steve Jessop Jan 29 '21 at 20:36
  • @SteveJessop Well, short-selling can result in price increases, as we have clearly seen. And the hedge-funds are putting their money into a position and taking the risk. Whether or not this manufactured short-squeeze was illegal or not, I think we can be sure that scammers are paying attention. Of course, I think the hedge-funds will be paying attention to WSB or similar forums now. It's probably best to not get out over your skis like this in the first place. – JimmyJames Jan 29 '21 at 21:57
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The biggest piece of information to understand is this: the number of shares short-sold actually exceeds the number of stocks in existence!

Gamestop wasn't chosen at random by the WSB folks - it had the record of the most shorted stock, at about 140% (a crazy high number).

All those short-sold stocks? They have to have their position closed at some point - which means that the person has to actually buy a share of the stock. And they might not have a choice - they have a debt of a stock, and if the value of that debt gets too large, the broker might force them to cut their losses (and buy the stock at that point in time.)

So the main two questions are this:

  • When are the WSB folks going to sell their shares?
  • When are the Hedge Fundies going to actually close out their positions?

The first one is very difficult to answer. The closest approximation I can give is of a Labor Strike. If a decent fraction of them cave and start selling, it could start a downward spiral (nobody wants to be the last one holding the bag.) Which is why the WSB folks are trying to keep unified together on it.

The second one is tough, because the fundies want to say, "This is just temporary; we'll wait until this blows over and then buy" when it's like $10/share." But they might not be given a choice, if the broker forces their hand to stop catastrophic losses. And if that happens? Well, there's another "nobody wants to be the last one holding the bag." Because 140% of shares need to be purchased at some point, and nobody wants to be the person forced out of a position buying stock for $10k+ per share.

Or another way to look at it is this: Gamestop's stock dropped from $30 to $3 in the span of 3 years (mid 2016 to mid 2019). This wasn't because the valuation got cut by 90%. It's because more and more hedge funds were shorting the stock (again, more shares were shorted than actually existed!) So you had a situation where the a potentially undervalued stock was only selling for $3 (because hedge fundies were flooding the market with additional shorted shares) and whose price might climb quite a bit as those hedge funds closed their positions. So people started buying the stock, even when it climbed to the pre-2016 levels. Not because they thought the company was necessarily worth that much - but because they knew there were an awful lot of shares that were going to be forced-purchased and it could cause a spike in price.

Kevin
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  • For "When are the WSB folks going to sell their shares?" - I can tell you that I, personally, if I had a stockbroker account right now, would buy one or two shares and never ever ever sell them. And I think a lot of people feel this way. Of course some people have already sold and made a profit, subsidized by people who feel this way. – user253751 Jan 29 '21 at 18:22
  • @user253751 - yeah, but it's a weird situation. It could easily be that it turns into an "infinity squeeze" like what happened with VW. Or, if enough WSB people decide to jump ship at, say, $500, and the hedge funds start closing their positions and alleviate the pressure, it could trigger a "jump ship before it's too late" on larger and larger portions of the WSB crowd. Dunno. Put it this way - I'm not willing to put my money where my mouth is, so I'm keeping my mouth tempered a bit ;-) – Kevin Jan 29 '21 at 19:02
  • odd to say "yeah, but" and then agree with me. I'm not saying I'm sure about what will happen, but I am saying we can't assume there will be a panic sale like there normally would be. – user253751 Jan 29 '21 at 19:03
  • Btw the 140% figure isn't shorts vs shares in existence, it's shorts vs floating shares. You (well, maybe not you, but Melvin Capital) can borrow non-floating shares to short. As it happens, I believe at some points the shorts did exceed total shares, but not by that much, just a few percent. Still you're right: enough shorting pushes the price down, just as enough new Redditors piling in pushes the price up. – Steve Jessop Jan 29 '21 at 20:27
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I find it hard to understand your question - it's rather disjointed, in particular it's not possible to run out of money as long as you don't put in new money. The folks on WSB bought the stock (or bought call options). As long as they don't buy more, they are not putting in new money, so they cannot run out of money.

Once they decided to move onto another stock them all selling, at the same time, will mean they'll all stand to lose a lot of money, i.e., they won't be able to sell the shares for what they paid for them.

Once they decide to move on (or take profits) and sell, then yes, the bubble will crash, GME will drop down to Earth, and whoever still holds the stock will lose a lot of money (in finance jargon this is known as "holding the bag"). So it becomes a mind game. If you sell now, you might lose out on making even more money if the short squeeze continues and the stock keep going up. On the other hand, if you don't sell now, the stock might crash tomorrow and you will be caught holding the bag. You want to sell just before the other people on WSB decide to sell, which is not something that is easily predictable.

But if that's what it is then it seems to me that the problem will eventually self correct ... ?

It really depends on what you consider the "problem", because for many people, there is no problem at all. Sure GME can gallop up and down, but if you're not invested in the stock, it doesn't affect you in the slightest.

Still, one thing we can say is that almost surely, GME will crash at some point. So "self-correct" is odds on to happen at some point. When that will happen, however, is something nobody knows.

Allure
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    I'm not sure you interpreted the question correctly. The question specifically mentions that it considers the ability "to [not] sell the shares for what they paid for them" as a loss of money. But your response effectively talks about loss of money in the context of losing money that is not yet tied up in stocks ("As long as they don't buy more, they are not putting in new money, so they cannot run out of money.") – Flater Jan 29 '21 at 11:04
  • In this situation, the beauty of options is that you can pull money out of a winning long call position, locking in profits and lowering your risk - which is not available with owning the the underlying. Yes, you take a beating because of the wide bid/ask spreads but it's a no brainer to do so when you have a call that is scores if not hundreds of points in-the-money. – Bob Baerker Mar 02 '21 at 22:29
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The point here is that the community as a whole is not going to make money, any more than say Bernie Madoff's (https://en.wikipedia.org/wiki/Bernie_Madoff ) investors made money. Those few who thought up the scheme and got it started, and who bought stock at the original price, will benefit if they sell the shares they hold before the bubble bursts. Those who are left holding shares that they bought at higher prices than the eventual final price will lose most of their investment.

Just a new form of the old stock kiting/pump & dump scam, IMHO.

PS: From recent news articles, it now seems that the people who really benefitted from this (perhaps entirely by accident) are the GameStop management & board, and other investors with large holdings, who were able to dump their shares in a failing company at greatly exaggerated prices: https://www.marketwatch.com/story/gamestop-shareholder-sells-off-stake-valued-at-over-1-billion-11611855951

jamesqf
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    You are missing the effect of Melvin Capital though. I fully expect WSB to make money as a whole. It just won't be evenly distributed throughout the community and half of them will make losses. – user253751 Jan 29 '21 at 18:23
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    Yeah, this really misses the boat. A lot of hedge funds were shorting the stock back when it was at $3-$5. If they're forced to close their position at, say, $500/share or $1k/share, it's not like the money they lost just disappears. It's not a zero-sum game for the WSB crowd - they're collectively pocketing the difference (though not necessarily in equal portions.) – Kevin Jan 29 '21 at 18:31
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    Most of the difference will go to whoever sells at the right time; those people will have already paid those who got in early, to get their stock, so the ones who got in early will also have made a profit. – user253751 Jan 29 '21 at 19:04
  • @Kevin What's really interesting is how this event demonstrated the limits of the short squeeze. Effectively, the situation got to the point where exchanges were unable to fulfill orders which led them to halt new purchases and only allow sales. The price tumbled immediately after. So while the short-sellers might not have seen the squeeze coming, the squeezers didn't see the limits of the scheme. – JimmyJames Jan 29 '21 at 19:39
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    @JimmyJames source for the claim: "exchanges were unable to fulfill orders"?? From what I have read, it was the brokers who halted buying only. The exchanges did not trip any circuit breakers that I could see. – Lawnmower Man Jan 29 '21 at 22:41
  • @Kevin: I think you misunderstood what I wrote. Some people in the community - those that bought shares at $10 or $20 (or who already held a bunch), and sold near the high - will make money. Those who jumped on the bandwagon at $100 or so, and who hold their shares until they drop back to $10, will lose money. Just like a classic stock kiting, just using crowd-sourcing to do it. – jamesqf Jan 30 '21 at 20:43
  • Yes, this really misses the boat. Consider this analysis which is hypothetical and simplistic: GME was 140% short. Assume that it's 100% and if it remains at 100% throughout. Every short share creates a synthetic long share. For the synthetic participants, it's a zero sum game as the long side makes every $ that the short side loses. A rise from $20 to $420 means a loss of $400 times 70 million outstanding shares and that dwarfs the idea here that because someone made $1 billion, then the community as a whole is not going to make money. A wad of money was made by many on the way to $500 – Bob Baerker Jan 30 '21 at 21:20
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    You said "the community as a whole is not going to make money". Which isn't true. Put it this way - the hedge funds have lost billions. If they lost billions, who won it? The community as a whole. Maybe not all of them, but to treat it as a zero sum game definitely isn't the right way of looking at it. – Kevin Jan 30 '21 at 21:20
  • @Kevin: You are not reading "the community as a whole" in the way I intended. What I meant is that SOME people in the community will profit - the ones that bought stock (or options) at a low price and sell at a higher one - but not everyone will. Other people in the community will lose money because jumped on the bandwagon later, and stayed on too long. And per the link I added, it seems that a lot of the money isn't going to the WallStreetBets people, but to those who just happend to hold a bunch of the stock before this thing started. – jamesqf Jan 31 '21 at 04:37
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    Your comments aren't lining up with your answer. Let me explain. You said "the community as a whole is not going to make money". You compared it to Madoff's scheme. And you called it a Pump & Dump. Those all equate to "For every dollar someone in WSB makes, it's coming out of the pocket of someone else in WSB." No. Not true. If you had simply said (in your answer), "Not all the WSB folks are going to make money on this," nobody would disagree. – Kevin Jan 31 '21 at 13:14
  • @LawnmowerMan WSJ "Webull Chief Executive Anthony Denier said his platform’s clearing firm, Apex Clearing Corp., notified him Thursday morning that Webull needed to shut off the ability to open new positions in certain stocks. Otherwise, Apex wouldn’t be able to settle the trades" ... “And if their clearing firm fails and there’s not enough collateral in the account to cover the purchase, that trade fails and will cascade into multiple trades with multiple customers.” – JimmyJames Jan 31 '21 at 18:02
  • @LawnmowerMan But that narrative doesn't work for all the bloggers looking to monetize righteous indignation or politicians looking to leverage it for support. – JimmyJames Jan 31 '21 at 18:05
  • @Kevin: Either I am not writing clearly, or you are (deliberately?) misunderstanding. I am saying that every dollar made here comes out of someone else's pocket. Part will be from the short-sellers, part will be from the WSBers who wind up selling shares for less than they paid. More interesting is where that money goes: I would bet that a lot goes to people who held shares bought at a low price, and who started the whole WSB frenzy with the intent of profiting. – jamesqf Jan 31 '21 at 19:34
  • Blackrock owns (or owned) 13% of the GME shares. So much for 'owning' the hedge funds. – JimmyJames Feb 01 '21 at 17:16