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In late January 2021, GameStop (GME) experienced an unprecedented surge in stock price and trading volume, becoming a focal point of financial markets and media attention.
Price and Volume Explosion
Over a three-day period from January 26 to January 28, GameStop's stock price skyrocketed, experiencing extreme volatility. On January 26, the stock was trading around $20 per share. By January 28, the price had soared to an intraday high of $480 per share, marking an extraordinary increase of 2,300%. During these three days, over 2 billion shares of GameStop were traded, reflecting an immense level of market activity and interest.
Robinhood's Controversial Decision
As GameStop's stock price surged, retail trading platform Robinhood made a controversial decision to restrict trading on January 28, 2021. Robinhood disabled the "buy" button for GameStop and several other highly volatile stocks, allowing only the selling of shares. This move effectively halted the upward momentum of the stock as it prevented new purchases, which were driving the price increase.
The Mechanics Behind the Surge: Gamma Squeeze and Options Market
The explosive price movement in GameStop was not primarily driven by the closing of large short positions (commonly referred to as a "short squeeze") but rather by a "gamma squeeze" in the options market.
Options Market Dynamics: A significant number of call options on Gamestop were purchased in the weeks leading up to January 28. Many of these options went in-the-money (ITM) as the stock price rose, compelling market makers to buy large quantities of the underlying stock to hedge their positions. This buying activity further propelled the stock price upwards.
Volume of ITM Options: In the weeks prior to January 28, a considerable amount of call options on GameStop became ITM. With the most options ever being exercised for Gamestop within its period on a public exchange. The exercised calls lead to more shares being purchased on the public exchange. This created a feedback loop where the rising stock price led to more options being exercised, which in turn drove the price even higher.
Hedge Funds and Market Dynamics
The rapid increase in GameStop's stock price caused significant losses for hedge funds that were heavily shorting the stock. Melvin Capital, one of the prominent hedge funds shorting GameStop, lost billions of dollars during this period. To help cover these substantial losses, Citadel, the largest market maker in the United States, extended a $2 billion loan to Melvin Capital. As the stock price rose, the margin requirements and potential losses for these short positions also increased. Hedge funds faced substantial pressure, and the intervention by Robinhood to restrict buying was seen by many as an effort to help stabilize the market and prevent further losses.
By turning off the buy button, Robinhood and other platforms curtailed the buying momentum, which was essential for the continuation of the gamma squeeze. This action allowed short hedge funds a moment of reprieve to manage their positions without the additional upward pressure from retail investors.
Gamestop Stock Short Squeeze Summary
The events surrounding GameStop's stock in late January 2021 highlighted the power of retail investors and the complex dynamics of the options market. The unprecedented price surge and trading volume, coupled with the controversial actions by trading platforms like Robinhood, underscore the evolving nature of market participation and regulation. However, people should ask themselves: was this really a short squeeze, or as individual GameStop investors termed it, a "short sneeze," suggesting it was a precursor to a potential real squeeze still to come?
If you want to learn more about why this wasn't a short squeeze and explore the intricate details of this market phenomenon, click below.