The trading world was recently rocked by an unusual development involving shares of GameStop, a brick-and-mortar video game retailer. Last summer, GameStop stock was worth $4 per share, and many hedge funds – including Melvin Capital Management and Citron Research – shorted millions of dollars in GameStop stock, expecting the price to fall further.
A short is when one party borrows stock from another party. Expecting the price of that stock to go down, the borrower sells the stock immediately, expecting to buy it for a lower price in the near future. The idea is to return the borrowed shares to the other party having profited off their decline in value. Short contracts specify a specific term; the borrowed shares must be returned by the end of that term, regardless of what the stock price is. Unfortunately for Melvin Capital Management and others, Reddit took notice of their big bet against GameStop.
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A group of Redditors on r/WallStreetBets recognized that hedge funds shorted more shares of GameStop than existed, and decided to stick it to them. When these online investors began using investment apps like Robinhood to purchase GameStop stock en masse, the price slowly began to increase. Just two weeks ago, the stock was worth $40 per share as others joined in on the trend. At the time of this writing, GameStop shares are trading at $338.
This is bad for the hedge funds that bet heavily against GameStop. Melvin Capital Management, for example, closed its position in GameStop after suffering losses of 30% in the first three weeks of the year. The hedge fund reportedly required a $2.75 billion financial support package from Citadel and Point72 Asset Management in the wake of the GameStop trading frenzy. This scenario is atypical of day trading and, while GameStop stock was up 80% at the time of this writing, such dramatic movement rarely occurs in such a short time.