The GameStop Situation: Simplified

[-]swarriner5y170

I am not a true expert, but there is one major element of this narrative that most coverage leaves out— no matter what happens to the short-sellers, the price of Gamestop and other short squeezed stocks must eventually normalize to a "truer" valuation.

I have seen a truly alarming lack of recognition of this fact, with some people apparently believing the squeezed price is the new normal for GME. Here's why that probably isn't the case:

The value of a stock is tied to two factors. One is (broadly) the cash flows one can expect to receive in the form of dividends and other shareholder benefits, the other is the expectation of the stock's value appreciating. Market manipulation like the current squeeze can cause the price of a stock to inflate based on that second factor. As the archetypal example, we look to the housing crash that caused the '08 recession. Thousands of mortgages were given out because it was thought that home prices would continue to rise indefinitely, meaning the loans were low risk (because even if the home buyer couldn't make their payment, the bank could seize the house and not take a loss). This was fine until it suddenly wasn't anymore; the assets lost perceived value, and the remaining fundamentals, i.e. homeowners' ability to service their debts, was not up to the task of keeping the banks solvent.

For Gamestop, I'm told there is some reason to think their fundamentals are getting better from where they were one year ago, but I have seen no compelling reasons that those fundamentals will deliver the kind of dividends that would traditionally command such share prices.

When the short squeeze passes, some Wall Street firms will have taken a big loss, but many small investors will be left holding a stock that may still nominally bear a $300+ price per share, but will probably not be able to deliver the same cash flows or stability as holding the same amount of a business with stronger fundamentals than GameStop. In the absence of people shorting, you end up deciding whether to keep your money tied up in GME, which will return $X over however long you hold it, or some other stock that could return $2x or $3x. At this point, after the short squeeze is resolved, the price will start to fall again.

The investors who were able to sell the $300 stocks to firms obligated to meet short contracts will realize a big cash gain, but anyone left holding the stock after that are likely to be in a seriously bad way.

This, of course, is not investment advice. If I knew exactly when the people holding GME were going to get nervous and try to liquidate, I could just take out new shorts and get rich ( and if enough people did that maybe WSB would just try to squeeze those shorts again!). What all of this boils down to is that this is not the new normal, it is a speculation bubble, and bubbles pop.

[-]Vaniver5y90

In particular, my understanding is that most people who shorted in the early days are now out (including, for some, giving up on shorting entirely) and have realized billion dollar losses, but short interest remains approximately the same, because new funds have taken their place. It was quite risky to think a stock at $4 would decline to $0, but it's not very risky to think a stock at $350 will decline to $40. It remains to be seen where the price will stabilize (and, perhaps more importantly, when) but I think the main story is going to be "early shorts lost money, late shorts gained money, retail investors mostly lost money).

[-]Borasko5y80

I haven't seen almost any traders going off a "real value" analysis for Game Stop. Almost everybody believes Game Stop has a broken business model with no fundamentals, but are all buying it and taking losses just to screw over hedge funds. This is coordinated short-sited financial shitposting out of spite. There is bound to be many losers, but man is it interesting to watch.

Edit: I would also love to see an analysis at one point of the game theory involved getting so many individual traders to coordinate.

[-]kjz5y140

It doesn't feel like game theory to me as much as psychology at this point. During the endgame, I agree game theory will play a huge role in individual investors' decisions to hold or sell. But now, it feels like a clear recognition that they are stronger together as long as they all hold, and what's most interesting to me are the simple slogans and short repeatable talking points they use to do so (as well as the excellent analysis that has gotten them this far).

"WE LIKE THE STOCK"

"IF HE'S STILL IN, I'M STILL IN"

"DIAMOND HANDS"

Why do they work so well? Because you only get five words.

It reminds me of an ancient army charging into battle, singing and chanting to maintain morale as long as possible during the struggle.

(Disclosure: I am long GME).

[-]Annapurna5y50

I agree with you, but that goes beyond the scope of my intention when writing this post. This post was meant to be as elementary as possible.

[-]Dagon5y30

There are a lot of paths where the "truer" value is actually quite high. Some amount of buyers will forget about it, and just hold the stock long-term. The company itself could find a way to capitalize (heh) on this, before it drops by too much - buy complementary valuable companies with stock, for instance. Even the press is probably valuable, and gives GameStop a great starting buzz for it's (future) online platform.

I'd bet (at lower odds than are implied by price of put options) it's going back down under $75, but no clue if that's over weeks or months, and that's STILL almost 5X where it started the year.

[-]Rafael Harth5y130

This post is similar to the one Eliezer Yudkowsky wrote.

[-]DTX5y90

I just can't get over that it's Game Stop. I remember when Blockbuster finally crashed in January 2010, I was convinced Game Stop was next and I shorted them then. Their valuation did decline a tiny bit and I made a small amount of money. 11 years later, I can't believe this company still exists.

[-]DirectedEvolution5y120

This is a great anecdote to show why it's not a good idea to try and time the market.

[-]norswap5y30

This explanation misses one major piece of the whole affair: it was not only a short squeeze (mostly, it was at first), but also a gamma squeeze (or gamma trap). It has to do with the hedging of option sales.

Here is a short explanation I wrote for a colleague:

gamma trap: most options are sold by market makers (e.g. investment banks), and they hedge the options they sell by purchasing (or selling) stock in order to be "delta neutral"
so if they sell one call at the money (strike price = current price), the delta is 0.5 (if the stock price increases by 1$, the call price will increase by 0.5$), and they will buy 50 shares to hedge (now if the price increases by 1$, they are up 50$ on the stock, down 50$ on the call, and they still profit by pocketing the premium)
as an option gets in the money (strike price < current stock price), its delta increases, meaning the market maker must increase the number of stock it purchases to continue being delta-neutral
here what happened is that redditors purchased a lot of cheap out of the money call options (low delta), and as the stock price rose and rose, these ended up far in the money, meaning the market makers had to purchase 100 stocks for each of these calls, driving the stock price higher, and pushing all calls farther in the money
ah, and gamma = the rate of change of delta depending on the stock price (so in particular here the fact that delta increases when an option gets in the money)