An Overview of the GME Rally
GME, the ticker symbol of GameStop, has recently been the center of discussion among Wall Street investors. The fervor over GME was started by a group of Reddit users who found that several hedge funds were holding large short positions on stocks like GME and AMC. The GME stock rally escalated as Reddit users urged others to participate in purchasing the shorted stocks, and in essence, it became a financial battle against the established Wall Street firms.
This led to the stock price skyrocketing from around $20 per stock to $396.50 per stock, its highest peak as of February 1st, in just two weeks-- augmenting its total return to 2500% this year. As a consequence, the hedge funds that held heavy short positions against the stock suffered massive losses: Melvin Capital, one of the hedge funds that betted vehemently against the gaming retailer, lost about 53% in January on their shorting positions.
Shorting, otherwise known as short selling, is an investment strategy that revolves around the speculation of a decline in a stock or other security’s value. Simply put, shorting is basically betting against the market: the investor profits from the value of the stock/security declining. In order to short, the investor would borrow shares of the stock or asset they deem to decrease in value by a fixed future date. Then the trader proceeds to sell these borrowed shares to buyers willing to pay the current market price for those shares. Before the deadline to return the shares, the investor will buy shares equivalent to the amount that was borrowed and will return the shares to the lender. If the trader has correctly prospected, he or she will profit from the difference between the value of shares at the time they were borrowed and the value of the shares at the time they are returned. The profit’s magnitude depends on the scale of the decrease in value of their invested shares, which has a limit as an asset’s value cannot go below zero. If the trader has misinterpreted the speculation of the stock, however, the trader can theoretically suffer from an infinite amount of loss as there is no cap to which the price of an asset can climb.
While many Reddit users proclaimed the rally as a “triumph of the commoners,” some are dubious if the whole rally can avoid any legal ramifications and argue that the reddit users’ encouragement to others in participating the rally can be deemed as a type of market manipulation. However, a number of experts including Gabriel Rauterberg-- a professor and expert in securities law at the University of Michigan Law School-- are skeptical if the collective act of sheerly promoting a stock can be validated in court as a form of manipulative trading activity as he notes that "manipulation law doesn't make it illegal for you to cause a stock price to deviate from its fundamental value” (Cheddar).
Some reflect this rally as a menacing precursor to future conflicts between regular investors and corporate-level investment funds. Considering that the reputation of hedge funds among many commoners have been impaired since the 2008 subprime mortgage crisis, it is no surprise that a significant amount of personal investors cheered as the price of the GME stock continued to soar. Will the Reddit users remain victorious as expected? Will the hedge funds, aided by new legislation ratified to prevent similar forms of market manipulation in the future, be able to short much safer? Regardless, the incident will surely be documented in economic history as a genuinely remarkable phenomenon.