Price action on GameStop GME has been extreme. The stock is up 20x since this time last year and 4x since a week ago. The reason appears to be a short squeeze as the stock has abnormally high short interest. However, volatility around such short squeezes is less unusual than you might think.
No New News
During this period of extreme volatility from GameStop there doesn’t appear to have been material disclosure from the company. Two weeks ago, on January 11th the video game retailer posted positive same-store sales over the holidays, and the company also adjusted its board members to drive more of an online retail focus. The absence of news suggests a short squeeze may be behind the price movement.
It appears many investors felt GameStop was a reasonable short candidate. Retail has been struggling over recent years, as online sales accelerate, and social distancing measures to slow the pandemic have generally exacerbated that trend. Therefore, some investors were betting on GameStop going down rather than up in price by selling the shares short.
The challenge is that in order to do that you must borrow the shares. If you borrow something you need to give it back. Especially as these transactions often happen on margin i.e. with borrowed money. So those short GameStop, may be seeing margin calls are the worst time as the stock skyrockets in price, helped by the Reddit subreddit wallstreetbets promoting the other side of the trade. For example, hedge fund Melvin Capital is apparently receiving a cash injection after losses that are believed to result from GameStop, and other short positions.
Other Shorted Stocks
GameStop isn’t the only stock surging without obvious news. Bed Bath and Beyond BBBY and AMC have all been extremely volatile in recent trading too. What these three stocks have in common is that they are among the most shorted shares in the stock market.
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Short interest for GameStop is estimated at almost 140% of its float. That’s extremely high. Short interest for Bed Bath and Beyond and AMC is at close to 70%. These are big numbers, typically short interest of 20% would be considered high. These stocks have massive short interest.
Short Squeeze Research
Short squeezes inducing price volatility is not all that unusual. Researchers Baixiao Liu and Wei Xu in their ‘Short Squeeze’ paper have found that during a short squeeze a stock rising by 20% in a matter of hours is, in fact, the average outcome. What we’re seeing with GameStop may seem unusual, but is not totally unprecedented.
In 2008 Volkswagen, like GameStop was a favorite of short sellers, but saw a massive rise in price over a short period in October 2008 when the stock doubled toward the end of the month. What happened after that? Volkwagen did fall back in price, but it took a few months to do so. Up fast, down slow. Researchers have seen that pattern too, short squeeze candidates can fall back in the months after they rally based on history.
This suggests that if history is any guide GameStop may fall back far more slowly than it has risen rather than coming crashing back down to earth, though it’s trajectory will ultimately be informed by its business results. But stocks jumping on short squeezes are not all that unusual, and not necessarily a sign that the market is seeing dislocation.