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The current Wall Street Bets theory behind the $GME rally goes as following:

  1. Hedge funds have shorted Gamestop to 140% by re-borrowing the same shares multiple times (or some other equivalent mechanism)
  2. Some traders have noticed this being the case and started driving up the price of Gamestop shares
  3. Hedge funds are losing money over this because they have to pay more interest per stock and because they're being pressured to return the borrowed stocks due to the high price
  4. At some point in the near future (weeks if not days) they'll be forced to close their positions which would drive up the stock price to $1000+, thus creating a massive transfer of wealth to small time investors

Does the last point actually have credibility? Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

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  • Note that this is not a duplicate of: money.stackexchange.com/questions/135411/…. I'm asking about the credibility of a very particular claim from WSB, not about the situation in general
    – JonathanReez
    Jan 28, 2021 at 17:30
  • "Couldn't short traders wait for many more months before closing their positions" -- Who would lend them stock while they wait for an inevitable price crash? The position can be closed from either side.
    – David Schwartz
    Jan 28, 2021 at 17:47
  • Actually I am wondering who currently gets the billions from 3). Like is it know who lend out a lot of these stocks?
    – lalala
    Jan 28, 2021 at 21:59
  • An important point to note here is endgame strategy. If you are holding onto millions worth of GME because you invested all your savings in December, what are you doing? Are you really waiting to hit 1000$ and risk losing everything if this does not happen? Remember this is a 'once in a lifetime' gamble gone right. It takes a lot of optimism and nerves not to cash in (at least partially) and indeed prices now seem to "stabilize" in the 300-350$ range
    – Manziel
    Jan 29, 2021 at 16:04
  • @Manziel that's the million dollar question, yes (literally for some like /u/DFV)
    – JonathanReez
    Jan 29, 2021 at 16:11

5 Answers 5

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Hedge funds are losing money over this because they have to pay more interest per stock and because they're being pressured to return the borrowed stocks due to the high price.

The cost to carry a short position in GME has increased for two reasons:

  • The daily borrow rate for GME has increased in the past few weeks
  • The share price has increased

However, this is not an unbearable cost or loss. The primary reason for the large losses is share price moving against them. If you short at $20 and GME hits $350, you're down $330 if you can hang in there.

At some point in the near future (weeks if not days) they'll be forced to close their positions which would drive up the stock price to $1000+, thus creating a massive transfer of wealth to small time investors.

Several hedge funds have already closed their positions and taken their losses. Probably many traders as well.

Bear in mind that there are other factors in play as well. Any Redditor looking to cash in has to sell some or even all of his position. That drives price down. As price drops, that enables option market makers to sell shares as well (purchased to hedge their short calls). I would imagine that new short sellers are also coming in at higher prices as well.

The confluence of these drives price down, as seen today from maybe $485 to $112. And then the buying pressure resumes and it's back up to $240. While $1,000 is possible, I think that it's also possible that at some point, new hedge fund money comes in short and crushes those still playing the game. Not a prediction just saying that price volatility is not likely to be over any time soon.

Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

The margin requirement is the primary determinant of being able to keep a short position open during a short squeeze.

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    "Several hedge funds have already closed their positions" => do we have proof that they've actually closed rather than merely saying they've closed?
    – JonathanReez
    Jan 28, 2021 at 18:07
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    "this is not an cost or an unbearable loss." Did you forget a word in "an cost"?
    – RonJohn
    Jan 28, 2021 at 18:14
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    Added a follow-up question: money.stackexchange.com/questions/135491/…
    – JonathanReez
    Jan 28, 2021 at 18:21
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    @BobBaerker but can any third party confirm if they actually did so in practice?
    – JonathanReez
    Jan 28, 2021 at 19:02
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    @lalala no. That takes time and there a regulations to follow.
    – RonJohn
    Jan 29, 2021 at 0:18
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This is the story WSB is telling:

There are two PS4s. Alice has one, Eve has one. Herbert knows that with the PS5 release, the price of a PS4 is going to fall from $300 to $100. So, Herbert borrowed Alice's gadget and sold it to Bob for $300. He planned to buy it back off Bob when the price fell and give it back to Alice. So far so good. Herbert got greedy, though, and then borrowed it back off Bob and sold it to Charlie.

Now, Eve looks at the situation and posts loudly on the internet "Herbert owes two PS4s. There only are two PS4s, and I have one. So Herbert has painted himself into a corner: he needs my PS4, and I can charge him whatever I want. Sure, he can have it. For 3 grand. No, 30 grand. I can literally make up numbers at this point."

It's a good story.

However, Herbert ignores her. He knows he's messed up, but he also knows she's wrong. He doesn't need her PS4 in particular. So, he goes to Charlie. "Hey mate, that PS4 I sold you, could I have it back? I'm really sorry, something's come up. I'll give you $600." Charlie says "sure". Then Herbert goes to Bob and says "Hey mate, here's that PS4 I borrowed. But actually, do you think I could buy it off you? I'll give you $600." And Bob says "sure". Then Herbert goes to Alice, and gives her the PS4 that he borrowed.

And Eve is left shaking her head in a disappointed sort of way.

What happened, at core, is that Eve thought Herbert owed two PS4s, and so the number of physical PS4s was some sort of hard limit on how he could fix things. Instead, he owed two PS4-transactions. He'd sold a PS4 twice, even though it was the same PS4 and wasn't really his to sell. So now he has to buy a PS4 twice to balance it, but it can be the same PS4 that he buys both times.

The most important lesson for us is, be careful when Eve says that we can buy her PS4 for the low low price of £1000 and Herbert is guaranteed to buy it off us for whatever we ask. We might wind up just giving Eve a grand for an outdated bit of tech and have nothing to do with it except put in in the cupboard.

There is of course some sense in which the story is true. Herbert does need to pay over the odds to fulfil his obligations. But he doesn't need to pay Eve. He needs to pay whoever will give him the best deal. If Eve and Charlie agreed that they won't sell for less than thirty grand, he'd have to pay one of them thirty grand. But that's illegal. And without a binding agreement, it's in Charlie's interest to be reasonable so that he gets the sale rather than Eve. So Charlie gets the sale, and Herbert doesn't have to blow £30,000 on a cupboard filler.

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    Charlie and Eve don't have to agree, the price is listed in the open and they can both see it's currently sitting at £30K
    – Jontia
    Jan 29, 2021 at 13:22
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    It's not $30k. No-one trades at £30k. The last trade was $300. Eve may advertise that she'll sell for 30k, just like Herbert may advertise that he'll buy for 10¢. Neither is the market rate.
    – Josiah
    Jan 29, 2021 at 14:56
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    Where Herbert really runs into trouble is when the story continues with "Herbert got greedy, though, and then borrowed it back off Bob and sold it to Eve (not Charlie)". So Eve is the only one in possession of any PS4s. Even then, Herbert is not required to buy one from Eve at the price she chooses. He can make a deal with Alice to buy back his IOU that she is holding.
    – Ben Voigt
    Feb 1, 2021 at 17:40
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    @Josiah: With options, closing by dealing in the option contract is common and well-supported. With stocks I don't think the people who loaned out the stock actually are sellers, at least not in a way that helps Herbert. Because the seller who loaned out the stock (Alice) has to have actual ownership in time for settlement, which means she demands back the stock he loaned out before settlement, and that's a problem for Herbert since he won't actually have it back until after settlement.
    – Ben Voigt
    Feb 1, 2021 at 23:17
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    @Josiah: While the price at which the last trade occurred may be the "market price", what really matters are the highest price of any pending limit order to purchase the item and the lowest price of any pending limit order to sell. If Bob sells Joe a PS4 for £4000, and then other people enter the market who would sell for £1000, but nobody other than Bob is interested in paying more than £400, the last-trade price will sit at £4000, but that will be an essentially meaningless figure.
    – supercat
    Feb 5, 2021 at 17:01
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Does the last point actually have credibility? Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

They can, if they have enough money (and can demonstrate it to the broker).

Let's say you sell a stock short at $10, but later it rises to $100. If the broker can see you have $100 available, then they'll be OK with you maintaining your position. But if you can't - they logically are going to do what is known as a "margin call" and demand you either close your position or add more money to your account.

Short selling is dangerous because there's no limit to how high the stock can go. If you buy a stock for $10, your maximum loss is $10. You can never get a margin call this way (assuming you don't leverage, which means borrowing money from the broker to buy the stock). But if you short sell the stock, you can lose $90 as in the example above, or even more if the price keeps rising.

GME stock has gone up by a huge amount, so it's not surprising that the original short sellers were forced to cover their positions.

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    The broker would probably require you to have more than $100, they'd want the $90 you'd already lost, plus some more to cover any losses they may incur if the security continues to rise and you don't have enough funds - if they decide you can no longer afford to hold the position they'll close it out which could incur more losses
    – David Waterworth
    Jan 29, 2021 at 5:33
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Does the last point actually have credibility? Couldn't short traders wait for many more months before closing their positions, giving the company plenty of time to collapse?

Yes, because of either getting margin called or rather untenable positions (e.g., a >1G USD potential loss).

In the case you mention, WSB short squeezing $GME, investment management firm Melvin Capital seems to have lost a few billions as a result of their short GME positions. See Citadel, Point72 Back Melvin With $2.75 Billion After Losses.

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Please please please ensure you understand the risk in trying to jump on a volatile bandwagon like this.

A statement like "At some point in the near future (weeks if not days) they'll be forced to close their positions which would drive up the stock price to $1000+, thus creating a massive transfer of wealth to small time investors", posted even after price dropped from $400+ to $200- today is a sign that you may have neglected to consider the actual risk taken on by assuming this is a 'sure thing'.

The whole GME situation smells to me like a lot of uninformed individuals putting more money on the line than they should be. I would also suggest that the driving force behind the price jumps are from individuals who stand to gain many Millions from the increases. Don't believe everything you read online...

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    I'm not a $GME investor, just trying to understand the credibility behind the theory. Lets focus on facts rather than generic warnings about the stock market being nothing more than a glorified casino (in the short term, at least).
    – JonathanReez
    Jan 28, 2021 at 18:09
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    note that (A) even $200 is a massive transfer of wealth to small time investors and (B) they are trying unusually dirty tricks to force the price down.
    – user253751
    Jan 28, 2021 at 19:32
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    @user253751 You misunderstand the situation. Redditors are buying shares at $100-$400, which in a week will probably be worth close to their old $20/share price. The short squeezes will provide an immediate price climb (which has largely been what we've seen thus far), but sooner or later, people will be holding shares that cost 10x what they are worth. The only 'wealth transfer to small time investors' will be those with ""WEAK HANDS"" who sell before the full price drop.
    – Grade 'Eh' Bacon
    Jan 28, 2021 at 19:51
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    @user253751 Correct - and of the non-short-sellers, who do you think will actually be left with a fat check at the end? Those with more market knowledge who step out early and leave others holding the bag, all while riling up the less informed by screaming "MOOOOOON" on Reddit. That doesn't result in a wealth transfer in the way you are looking for.
    – Grade 'Eh' Bacon
    Jan 28, 2021 at 20:02
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    If someone asks "Would hitting my head with this hammer hurt the hammer?", a pretty good answer would be "Please don't hit your head with a hammer, that has a lot of risk", even though the technically-correct answer would be "If the hammer is weaker than your skull, yes it could hurt the hammer".
    – Grade 'Eh' Bacon
    Jan 29, 2021 at 16:30

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