The GameStop Saga Isn’t About Finance, It’s Part Of The Ongoing War Between Elites And Populists By Sean Davis for The Federalist
The rules here are simple: Heads Wall Street wins, tails you lose.
For those who haven’t heard, there’s a bit of a brouhaha brewing with the video game retailer GameStop, which is publicly traded. Much of Wall Street soured on the company, believing it to be the next Blockbuster or Radio Shack: a dinosaur from a bygone era that has no hope of succeeding in the increasingly internet-run future. As a result, a major Wall Street hedge fund worth billions decided to make a bet that the company’s already low stock price would just keep going lower.
The traditional way to make money in stocks was to find a company that was worth more than what its stock price indicated, purchase the stock at a bargain, and then make your money either through the company’s distribution of its profits back to its equity owners or the appreciation of its stock price. Buy low, sell high. But you can also make money betting on a company to eventually circle the toilet. This is called shorting.
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To make money off a company that’s not making any, you “short” its stock by borrowing a share from an existing owner, immediately selling it and getting the cash proceeds from the sale, and then buying back the stock when its price dips and returning the share to the original owner. It sounds simple enough, but it’s also extremely risky.
Because you’re borrowing an asset, you have to pay interest on that debt, and over time that can get increasingly expensive. Even if the stock drops like you expected, those carrying costs can destroy any profit margin you thought you’d earn. And if the stock price goes up, you could be facing financial ruin. That’s because when you short a stock, your losses are potentially unlimited.
Think about it this way: If you buy a stock for $25, the most you could possibly lose if the entire investment went belly up and the price fell to $0 is $25, the price you paid for the stock. On the flip side, your gains are potentially unlimited, because who knows how high the stock price could go.
Shorted stocks are the exact opposite. If you short a stock at $50 — you borrow the stock, and immediately sell it at the current price of $50 — the most you’ll earn is $50. When the stock approaches $0, you’ll buy it for pennies, return the share back to the investor from whom you borrowed it, and the difference is your profit.
However, if the stock price goes up, so do your losses. If it goes to $100, you have to buy it at $100 in order to return it to its rightful owner. But what if it goes to $1,000, or $10,000? Your losses could be infinite. The same goes for the various baskets of options and stock derivatives that can be used to mimic the payouts of stock shorts.
This brings us back to GameStop. A major hedge fund had a massive, and very public, short position on GameStop. Enter Reddit. A bunch of Redditors who followed the stock market realized that this billion-dollar hedge fund had a problem on its hand: Due to a combination of factors, GameStop somehow ended up with more short positions than outstanding shares.
