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The Curious Case of the GameStop Short Squeeze

Enemy at the Gate

Written by Briton Ryle
Posted February 1, 2021

It was virtually impossible to avoid the Reddit/GameStop saga over the weekend. Even sports talk radio here in Baltimore couldn't resist the story. It's pretty easy to see why. It's a real "power to the people" situation. Just to review, a bunch of people that follow a Reddit topic called r/wallstreetbets started buying shares of video game reseller GameStop (NYSE: GME). GameStop is a failing company. It has been swirling the drain for years — I honestly don't know how it's still in business. Seems like one of those discount retailers that has "going out of business" sales every few months but never actually goes out of business. 

GameStop's financials are so bad, it is considered a slam-dunk short opportunity for those that like to sell a stock first and then buy after the price has fallen. Though, in this case, most of the short sellers never thought they'd have to buy the stock. It was obvious that, at some point, GameStop shares would be worth zero...

At least it was obvious until these Reddit jerks traders threw a monkey wrench into the works. 

Just kidding about that "jerks" thing. Sure, the Reddit people are getting called "barbarians," "unsophisticated," "misinformed," and I'm sure much worse when the mics aren't on. The CEO of Interactive Brokers even went so far as to say they were actually breaking the law by buying GameStop. 

Personally, I love the fact that these traders are using the free market system and information that is available to anyone to stick it to the proverbial MAN.

Plus, the financial/investment "elite" are really showing their stripes here. It's like, oh bending the rules and gaming the system is fine so long as it's a high-flying hedge fund manager doing the gaming. But now that it's a buncha yahoos on a message board doing the gaming, well, they're calling for the game to stop. 

Risk Management and the Concept of Value

So Interactive Brokers has made the decision to actually liquidate the GameStop holdings from some accounts. Yeah, they sold it. It sounds downright rotten on the surface, but if the account holders used margin to buy GameStop, well, forced liquidation is the easiest way for a broker to reduce its risk. After all, margin is just a loan from your broker. If the broker is concerned that you won't be able to pay it back, well, liquidation is reasonable...

Interactive Broker CEO Thomas Peterffy should've just stopped talking at that point. Sadly, his mouth kept moving and words about "value" started coming out — as in there's no value in GameStop stock; there's no way anyone can buy the stock thinking that the GameStop company is going to improve its potential as a viable company. 

Sigh. 

Do I really have to explain the concept of trading to the billionaire CEO of a major brokerage? 

Trading stocks or options has nothing to do with the intrinsic value of the underlying company. And by "nothing" I mean ZERO, NADA, and ZILCH added together and multiplied by a big goose egg. 

I don't care if you use stochastics, Bollinger Bands, and MACD or if you just throw a bunch of goat bones on the ground. Technical analysis is designed to reveal what people are buying or selling so that a trader can hop on board and scalp a quick profit. Value is completely and utterly irrelevant, as are the good CEO's musings on what constitutes value.  

I should add that many traders (including me) like to see high short interest in a stock. Short interest shows you how many shares of a company are sold short. A short position represents stock that must be bought at some point. It's buying pressure that must happen at some point. Every trader knows that if a shorted stock starts rallying, there's a good chance that shorts will start closing their positions and that buying pressure will help propel the stock price higher. 

So far as value goes, Ben Graham had some good ideas about how to value a company. But last time I checked, it wasn't illegal to buy a company with a P/E so big it looks like a Social Security number. It better not be... or Standard & Poor's has some 'splainin to do about putting Tesla and its trailing P/E of 1,500 on the S&P 500. 

Value is and always will be in the eye of the stockholder. 

The Market Is Doing Its Job

You might consider yourself a dog person. Dog people never like it when a dog barks at them, but the dog is just doing its job. 

Likewise, in the case of GameStop, the stock market is doing its job. The only arbiter of right and wrong in the market is your P&L statement. If you made money, you are correct. If you lose money, you were wrong. Period. End of story. 

Somewhere along the line, Melvin Capital revealed that it was short shares of GameStop. I think the words "significant short position" were used. And somehow, miraculously, it got caught in a short squeeze that wiped out half its capital. Huh. You don't say...

PRO TIP: Don't announce publicly what your position is — ever — especially if it's a ridiculously one-sided trade like "short GameStop."

It doesn't matter how clever or deceptive, the stock will always find you out. It will always know your personality defects. In this case, a bunch of Reddit traders exposed Melvin Capital's defect: hubris. There's a lot of that going around on Wall Street these days... 

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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