Ok, so, in case you have not heard, there was this really weird thing going on with GameStop stock. GameStop, in my opinion, is going the way of Blockbuster. They have brick and mortar stores, and sell physical discs for video games, which, hello, the industry is heading towards everything online, especially with downloads of games. Everything is always evolving and honestly, if you do not evolve too, you are going to be left behind.
Tom Friedman from the NY Times had a fantastic analogy about lions, wildebeests hyenas and vultures that can be viewed here:
But what it boils down to is this: Large hedge funds on Wall Street saw that GameStop was not doing so hot.
(Side note, Jill’s plan: A Hedge Fund is a small group of experienced investors that gets together to invest large sums of money, sometimes their own and most of the time borrowed money and takes usually high-risk methods to try to get big returns. The average investor does not typically have access to these, although we are seeing more and more pension funds and endowments use these type of investments. Essentially, you have to be a very big fish.)
So, the hedge funds sold GameStop stock short. What does this mean? Well, we all know that you can buy stock low and want it to go up so you can sell it at a price higher than what you paid for it. The other way to buy stock, is essentially to “borrow” the stock now, and sell it, at its current price, which, in a short sale, you are expecting/hoping the price to go down, so you can buy it back at a lower price, and then pocket the difference.
Example: I short sell a stock called Phat Finance at a price of $50, so I essentially borrow the shares and sell them at $50. I think it is going to tank, and a few days later, it does, and now the price is $20. I buy the shares back at $20, and now my profit is $30. It is selling a stock you don’t have, because you think it will go down in price and you can buy it back lower.
Well, what happened was, a group of people on this Reddit board called r/WallStreetBets discussed trading the GameStop stock and decided to buy shares of it (and call options) amongst themselves and in effect, drove up the price of the stock, almost 1000%.
So, now the hedge funds have a serious problem, because the stock that they sold at one price, and have to buy back to ‘cover their short sell’ is like, WAY higher than they wanted it to be and they lost money. Some to the point where buying it back is more money than they even have in their hedge fund. We are talking billions of dollars here. And the Reddit users are not just doing it with GameStop, they started doing this “short squeeze” on other stocks too, AMC Theaters, Nokia, etc. The traders were using apps like Robinhood to buy their stocks, and then the hedge funds got mad. And this past week,
Robinhood and some other e-traders actually halted buying these particular stocks due to all the craziness. Which then led to a huge “little guy vs the rich evil people of Wall Street” debate, etc. etc. etc.
What does this mean for you?
Well, for one, it is incredibly fascinating to watch this all play out. But there are some valuable lessons to take away from this:
- Do not try to buy these stocks right now. It is WAY too late to the party to get on this yourself. These stocks have been artificially inflated by market manipulation, and at some point, will likely crash. If you do not sell in time (which, who knows when that will be), you could be out a lot of money.
- You should really only buy this kind of stuff with money you can afford to lose. Buying individual stocks is risky in general and dealing with these type of “bandwagon” stocks is especially risky. It’s usually better to stay diversified.
- The apps like Robinhood that make it easy for the masses to trade stocks, are also essentially making it a game. And sometimes people do not understand that it is a game. Are you reading the fine print on the disclosures before you “click here to agree?” Are you making bets with money that you should not, like your retirement or emergency savings?
- Margin can get you into trouble. To make a short sell where you borrow the stock, you have to do this in a margin account, and you can technically trade on borrowed money which, you do have to eventually pay back. In the same way that credit cards get some people in trouble, so do margin accounts.
You really need to know what you are doing if you’re dabbling in this space. Just like having a hangover from indulging too much the night before, there are no do-overs. You do not want to be in a position of regret. Please talk to a professional before getting involved.
Options involve unique risks, tax consequences and commission charges and are not suitable for all investors. When appropriate, options should comprise a modest portion of an investor’s portfolio. No statement within this document should be construed as a recommendation to buy or sell a security or to provide investment advice. Prior to making any options transactions, investors must receive a copy of the Options Disclosure Document which may be obtained from your financial institution.
Any opinions are those of Jill Carr and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation.