Game(stop)

There is this scene from Trishul (released in 1978) when Amitabh Bachchan (Indian Superstar)  comes to Sanjeev Kumar to strike a deal of Rs 500K (worth USD 160K in today’s money) with pennies in his pockets. To me this sums up what is going on with the Gamestop stock story in the US currently.

The story line of Trishul as a parallel to the Gamestop story:

Rajkumar Gupta (Sanjeev Kumar) leaves his first love Shanti (Waheeda Rehman) to marry a wealthy girl. Shanti raises her son from Rajkumar, Vijay (Amitabh Bachchan) to adulthood in abject poverty (read financial crisis 2008). After she dies, Vijay (read: WallSreetBets) comes to town to take revenge by destroying his father’s (read: Hedge Funds) business.

Like the 3 hour long movie, the Gamestop  story also has enough twists and turns.

Skip directly to a detailed blow by blow account. Or else continue reading this short version of what transpired before moving on to the detailed account.

• June 2019 DeepFuckingValue starts buying call options on $GME(Gamestop) – Shares trading at $5.4.
• Short interest building up in $GME.
• Aug 22nd 2019 Michael Burry discloses his 3% stake in $GME – Shares trading at $4.3.
• Aug 2020, the founder of Chewy (online pet store) Ryan Cohen takes 9% stake in GME.
• Nov 2020: A user on WSB highlights that a hedge fund Melvin Capital is going long on GME put options.
•  Dec 2020: Ryan Cohen increases his stake in GME to 12%. Shares trading up to $20.
• Jan 2021: GME adds Ryan Coven to the board and gives 2 of his affiliates (his former COO and CFO) board seats; Shares trading around $20.
• Jan 12th/13th: tons of activities on reddit/wsb and or discord channels heating up the activities on $GME counter as shares started moving.
• Jan 21st: Short interest is up at 130%.
• Jan 25th: Melvin Capital keeps bleeding as shares went up to $77; they have to raise capital ($3bio) from another big hedge funds in US.
• Jan 27th: Elon Musk tweets about it; shares hit a peak of $475.
• Jan 28th: Brokerage firms like Robinhood prohibit people to buy GME as they didn’t have enough liquidity.
• Jan 29th: Citron Research announce they covered the shorts; shares close at $325.
• Feb 2nd: Short interest goes down to 50%; shares trading at $90.
• DeepFuckingValue has made a return of 260 times on his investment in 18 months.
• Feb 6th: Shares trading at $64.

Jump to lessons learned, or continue reading for the detailed version.

Here’s a detailed version

The story began not that long ago in June 2019 with a reddit channel called u/wallstreetbets and the hero of this story is a user named u/deepfuckingvalue (u/dfv).

June 2019: DeepFuckingValue , started buying call options (explained below) on $GME(Gamestop) when the shares were trading at $5.4. He started buying those call options expiring in 18 months i.e January 2021. He spent $50k buying these options. Now I know what you must be thinking.

Call options gives the buyer of these options the right to buy a stock at an agreed price on an agreed date. The buyer expects the price of a stock to increase when he buys a call option. The maximum amount a buyer can gain is infinite while the downside is limited to the option premium. For example you buy a call option paying Rs 10 (option premium) on a stock currently trading at Rs 100. If the stock price goes to Rs 130, you have a right to buy at Rs 100 which means a profit of Rs 20(130-100-10) i.e (Future Stock Price- Current Stock Price- Option premium). Had the price gone to say Rs 70, your loss would be Rs 10 which you paid for the option (Option Premium).

Meanwhile: Short interest or short selling (explained below) was building up in $GME.

Notably, as of July 31st, 2019, Bloomberg reported short interest in GameStop stock at about 63% of the outstanding GameStop shares.

Short selling of shares is when market participants sell shares that they don’t own and then buy them back at a future date. Market participants aim to profit from short selling if the price of the shares falls. This is therefore different from the typical investment perspective, where the investor aims to benefit from the rise in price of shares (considered a “long” position). A high percentage of short interest means market participants are increasingly pessimistic on the stock.  For example If a stock price is INR 100 and an investor expects the price to fall to INR 60, one can sell the shares today and buy them back at INR 60. The profit thus is INR 40(100-60). A high percentage of short interest means market participants are increasingly pessimistic on the stock.

Aug 22nd, 2019: Michael Burry discloses his 3% stake in $GME. And yes, this is the same Michael Burry from the famous Big Shorts. $GME was trading at $4.3 at that time.

Following this, u/DFV wrote this post on reddit in Sept 2019.

One year later, July 28th 2020: u/dfv live streamed this video detailing his bullish case for $GME. This will put many analysts (read as brokerage research) to shame, who miraculously always have a target of 20% higher than current market price.

At this point, shares were trading at $4.00.

Aug 2020:  Founder of Chewy (online pet store) Ryan Cohen takes 9% stake in GME

Now, shares were trading at $6.59, up 22.26%.

Sep 19th 2020: A member of wallstreetbets writes

• There is 120% short interest (explained below) in stock and mostly losing money
• There is a new console coming in soon
• Gamestop had 55 mio loyalty users
• Company has net cash position of $300 mio

This lead to a bullish sentiment and shares are now trading near $10.

How can you short more than 100%: Good question! Let us say there are 100 outstanding shares of company X held by investor A. Investor B comes in, borrows these 100 shares and short sells them to investor C. Which means, outstanding shares=100, short interest =100. Investor B borrows these 100 shares again from C and short sells them to investor D. So now, short interest is 200 and outstanding shares is 100. So short interest now 200%

Nov 2020: One of the users WSB highlights that a hedge fund Melvin Capital is long put options (explained below) on GME (meaning Melvin is expecting share prices to go lower).

Suddenly WSB found their enemy- Melvin Capital (remember Balwant Rai aka Prem Chopra (famous for his roles as a villain) from Trishul).

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Put options give the buyer of these options the right to sell a share of the company at an agreed price on an agreed date. It’s the opposite of the call option (explained earlier). Like in short-selling, the buyer of put options also expects stock price to decrease, but here, the buyer limits his/her downside. Because, the only amount at risk is the premium paid to buy the put option. If the price has not decreased, the buyer is not obligated to buy at the higher price, whereas in short selling the buyer is obligated to complete the sale at the future date.

Rewinding to the short selling example given earlier –  You buy a put option paying Rs 10 on a stock at strike price of Rs 100. If the stock price goes to Rs 130, you can choose to not buy it and therefore your loss would be limited to the Rs 10 which you paid initially for the option. Had the price gone to say, Rs 70, you could buy these and your profit would be Rs 30 (because you have a right to sell something at 100 that is actually trading at 70), subtracting the Rs 10 which you paid to buy the option. This would amount to a net profit of Rs 20 (100-70-10).

Let’s have a look at how things unfolded in the months of December and January.

Details Below

Dec 2020: Ryan Cohen increases his stake in GME to 12%. And later in Jan 2021 GME added Ryan Coven to the board. Shares are now trading around $20.

Jan 12th/13th 2021: Tons of activities on WSB and or discord channels heating up the activity on $GME counter.

Shares trading up 100% in less then a month to $40.

The war is on between Wall street Bets and the Hedge Funds.

The story is now heading to its climax.

Jan 19th : Citron Research announces that they were also short on GME expecting prices to go down to $19. Shares trading at $40.

Citron Research replaces Melvin Capital as public enemy no 1 for WSB.

Jan 21st: Short interest shoots up to 130%.

Jan 25th: Melvin Capital keeps bleeding as shares go up to $77. They have to raise capital ($3bio) from other big hedge fund in US called Citadel LLC.

Jan 27th: Elon Musk tweets about it. Of course he has a hate relationship with short sellers which includes Melvin Capital as well.

Later that day on Jan 27th: Melvin Capital announces that they had covered the shorts the previous day. Shares rocket to a record closing high of $347.51 on January 27, touching intraday highs of over $450

Jan 28th 2021: Brokerage firms like Robinhood prohibits people from buying GME as they don’t have enough liquidity.

Aside: How does Robinhood make money if they are a zero brokerage firm?. They make bulk of money ($400mio) yearly from selling the same orders to firms like Citadel LLC. Who is Citadel?, the one that rescued Melvin Capital…(Golmaal hai bhai sab golmaal hai)!!!

(The Robinhood story for another day!)

Jan 29th: Citron Research announces that they covered their shorts.

Stock closes at $325 on 29th Jan.

So Melvin out, Citron out.

Where are we today?

Short interest in GME which was hovering around 130-140% of underlying stocks has since dropped to 50%, primarily as funds like Melvin have covered their short positions.

Where is u/dfv?

His post on Jan 27th when $GME price was $347 is shown below. His maximum value of the portfolio on that day was at $48mio. (remember he only invested $50K)

The last update was on Feb 3rd when price was $90. His portfolio is down to $22mio as price dropped down to $90.

As you can see he has encashed $13mio which is showing up in cash. So even if price goes to zero he has made his $50k into $13mio or a return of 26000% (over 260 times) in just about 18 months.

At the same time he is also still long the shares and call options.

Where is GME trading now?

The stock is trading at $64 (as on 6th Feb) after touching a high of $475.

But what should be the right price of GME? Who knows!

As Warren Buffet famously said, “price is what you pay and value is what you get.

Ashwath Damodaran, NYU professor tried to price it and came with a valuation of $47.

–>So was u/dfv stupid to buy it? Remember he bought it when stock was at $4 in June 2019. And he has already encashed $13mio from it.

–>Oh so Melvin Capital was smart to short it? Remember they were short 5mio shares at well below $10 (probably around $5).

It is estimated Melvin Capital lost 53% of its value in January.

Come on what’s the ending? Is this happy ending or sad ending?

Picture abhi baaki hai mere dost. (Movie is still continuing)

The Reddit channel is still active, u/dfv id still invested, Melvin and Citron have left the waters but other hedge fund sharks are still lurking. So keep watching the space for more.

Lessons from this saga

Is this just a story or do we learn anything from this whole episode?

Of course this is an historic event and it does teach a few things.

• Stock prices tend to follow fundamentals only over a very long term; in the short term the collective judgement of investors that impact demand and supply are bigger factors.
• Stocks can remain overvalued or undervalued longer than one can remain solvent.
• Short selling has unlimited downside so should be done with care.
• Should short selling be banned? Not really as short sellers play an important role in the markets; but here there should always be market wide limits on short selling.
• Retail investors coming directly into stocks is a trend which will only grow as technology becomes more accessible.
• People putting in their own money at risk have skin in the game vs people playing with others money.
• You have higher chance of winning if you do your own studies than getting influenced by some else’s trade ideas.

Cheers!!