By Tony Jiao, Staff Writer
At this point, anyone even remotely involved in finance will have heard of Gamestop’s wild ride over the past year. However, despite many expert opinions and analyses, very few answers have been put forth to explain Gamestop’s erratic price action almost exactly a year ago. With the anniversary of Gamestop’s rise to nearly $500 a share looming on the horizon, how much do we really know about this once-in-a-lifetime internet sensation?
Right now, several theories are circulating around the internet that attempt to explain Gamestop’s sudden price increase. The two most prevalent of these, which were examined in detail in a report by the Securities and Exchange Commission, are that either a “short squeeze” or a “Gamma squeeze” may have taken place. A short squeeze occurs when short sellers, faced with a sudden increase of the stock that they are “short” on, either must post additional collateral to cover their liabilities or exit their short position. When exiting a short position, the party that is “short” must buy back all the shares that they owe, which causes an inevitable increase in price, putting other short-sellers at risk.
Given the sudden drop in Gamestop’s open short positions shortly after the end of the runup, this seems like a likely explanation. However, the SEC is skeptical. In their report, they agreed with most Reddit investors: a short squeeze was likely not responsible for the price action in January 2021. They especially noted that many ETFs, which are basically a “basket of stocks”, containing Gamestop experienced similar volatility during January. They specifically singled out XRT, a retail-focused ETF that had and still has multitudes of total existing shares sold short as of December 31, 2021. The SEC suggested that short parties, robbed of the option to directly short Gamestop, instead turned their attention to ETFs that contained Gamestop in an effort to indirectly impact its price.
Another theory put forward is that Gamestop’s price action was due to a “Gamma squeeze”. To understand this term, one must first understand the fundamentals of options contracts. Options, made up of calls or puts, essentially give the buyer of the contract the right to buy or sell shares at a certain strike price, respectively. Options contracts are usually drafted by Market Makers, and their associated risk is gauged by 4 variables: Delta, Gamma, Theta, and Vega. Delta measures the change in the price of the underlying asset, while Gamma measures the change in Delta. Gamma is typically used as a “forecast” for the price action of the underlying stock.
When a Market Maker drafts a call option, they are promising the buyer of the contract that they will sell them 100 shares of a stock at the strike price. The buyer enters this contract hoping that the stock will rise above the strike price, while the Market Maker hopes that the stock will fall since the Market Maker must purchase these shares from the open market. During a Gamma squeeze, a massive influx of call options forces the Market Maker to buy a similarly massive amount of shares from the open market, driving up the price of the stock and incentivizing more investors to purchase call options.
The SEC is similarly dismissive of this idea. Even though options trading activity increased massively over the span of a few weeks, from $58.5 million on January 21 to $563.4 million on January 22 to a whopping $2.4 billion on January 27, the government agency discovered that this activity was mostly driven by the buying of puts, rather than calls. As well, further research showed that market makers were actually buying, not selling/writing call options, which seems to discredit the gamma squeeze theory.
One year after Gamestop’s history-making rise to the forefront of financial, and indeed world news, still precious little is known about the specific details behind the event. With the one-year anniversary approaching, answers may become more apparent. On January 14th, an enormous amount of options are set to expire. Whatever the true cause of Gamestop’s runup, this week is sure to bring more questions than answers, with or without another “moonshot”.
To read more of our coverage on Gamestop, click here.
Photo by Branden Skeli on Unsplash