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GameStop Shenanigans Explained

‘Expect the unexpected’ is an expression that is applicable now more than ever, especially amidst a pandemic. The expression’s relevancy continues early in 2021 in the financial markets. Last year, an unexpected novel virus shocked the overall stock market and stocks dropped about 30%.

This year, GameStop, a retail store selling video games and consoles, has been up as high as 2,000% this month (as of the time of this writing). That percent was not a typo: two thousand percent! GameStop is considered by many an outdated retail store because people can now download video games without even leaving their house. And a significant jump in its stock price was certainly unexpected to investors.

What is causing this stock to jump? GameStop is in the middle of a battle between Wall Street hedge funds and retail investors. Hedge funds are private investment pools in which the investment manager seeks higher returns by using high risk instruments and strategies such as call options and shorting stocks. The hedge funds made a “bet” against GameStop in which a downward stock price movement would be profitable for them. This “bet” can be termed “shorting stock”, or a “short position” in finance.

On the other side of this bet are investors hoping for the stock to go up, and in this case, particularly retail investors. Retail investors are uniting using social media apps (such as Reddit) and commission-free trading platforms (most notably Robinhood) to rally against hedge funds and encouraging others to purchase the stock. These retail investors are driving up the price of the stock by either buying the stock or making their own bets buying risky call options. A call option is a contract between an investor and someone else agreeing to sell the contract. Additionally, for the hedge funds to close out their bets, they must also buy the stock to stop their losses from growing – this is what is called a short squeeze. To summarize, we have retail investors, electronic trading companies, AND hedge funds buying the stock sending its price sky high.

GameStop has not been the only stock in this situation. Stocks such as BlackBerry, Bed Beth & Beyond, and American Airlines have also surged this year driven by the social media fueled push from retail investors. This trend has bled into sectors with lower stock prices caused by the virus, such as travel stocks.

Our view at Dougherty: if GameStop, or any other company, underperforms in its operations and profitability, its stock will ultimately drop. Therefore, speculators who temporarily drive up the company’s stock price to artificially high prices will ultimately lose.

At Dougherty & Associates, we do not participate in these riskier trading strategies, such as options, establishing short positions, or even chasing stocks that we think will make a quick jump. We remain optimistic about our core stocks and mutual funds as long-term investments. The mutual funds we invest in are more conservative and regulated by the SEC, compared to a hedge fund that is operated by a private company. As always, please call us with any questions.

John