Financial. My name is joe brown, and today we are looking at the insanely massive historic rise in the share price of gamestop stock. I mean you’ve, probably already seen it already, but just look at this chart i mean i even have it right here back on my computer screen. You probably can only see the the little tiny line that runs along the bottom, because you have to zoom in to be able to see any of this recent pop here, it’s just just a straight line up over the last couple of weeks. Basically, so today we are going to look at the reason why gamestop stock has been skyrocketing, and there are two reasons why to and guess what you probably could have guessed this already, but it has absolutely nothing to do with fundamentals. Nothing about the company changed! No news announcements: no unexpected uh, spiking earnings, no new, ceo, no, nothing like that, has nothing to do with fundamentals, but there are two reasons that are contributing to the massive spike ready let’s dive in alright guys. So you can see that just a couple of months ago, gamestop was trading right around five dollars per share and, as of today, i’m recording this video on friday january 22nd. The stock exceeded 75 per share at one point today and before the close it’s still over. Sixty dollars per share, so that means, if you would have bought it just a couple of months ago, five bucks per share and held it you’d, be currently sitting on more than a 10x gain on your shares for a company again with no fundamental change.
So what is going on here, two reasons, the first one is a short squeeze and the second one is delta hedging. So let’s talk about the short squeeze first for anybody, who’s not familiar with what a short squeeze is let’s break it down. Gamestop is not actually that great of a company there are a lot of people out there, especially professional investors, who are looking at the company and thinking hey. This is a company that probably has to go down over time. This is a company that is heavily reliant on their retail space. They’Ve got a lot of high overhead they’re reliant on malls. That was where a lot of their revenue came from uh, for you know, for a long period of time and as the the shift in retail changes and as the shift in gaming takes place where people don’t go into stores as much anymore to shop for games. All you’re going to do is just download the game from the internet you’re not needing to go in and and buy the discs anymore. Because of this there was a very high short interest on the stock. So what does that mean when you uh, when you’re trying to trade a stock, you can do one of two things: you can either buy it or you can sell it now for anybody who’s not familiar with shorting. This might come as a little bit of a surprise, but you don’t always have to do it in the order of buy first sell.
Second that’s, just a normal trade when you buy something you’re. What you’re, hoping that happens is that that thing goes up in price and then you can sell it later for a higher price, and then you make the the profit off of the in between when you short something all you’re doing is reversing the order. You sell something first and then buy it later. So take this as an example, you’ve got a buddy who has has an old iphone sitting in his closet. He doesn’t use it. He just has it in his closet, let’s, say: it’s an iphone 10. now you’re. Looking at the calendar – and you think, okay, another iphone is going to come out in about nine months, and so by that time the the iphone 10 is going to be worth a little bit less than it is right now, so you go to your buddy and You say: hey you’ve got this iphone in your closet, it’s your backup iphone, and i want to borrow it from you. Just lend it to me and if, for some reason something happens to your current iphone over the next year, let’s say you want to borrow it for a year, uh and uh. If something happens to his current iphone, you tell him hey, i’ll, you know i’ll, give it back to you at any point. You can. You can demand it back from me, but your plan is to uh return it in a year.
So what you do when you get that you borrow that from him you immediately go post, something on on ebay and uh or craig craigslist, and you say: hey iphone 10 for sale, great condition, so you sell at the current price. Now you wait one year for the new iphones to come out and all of the other iphones to drop in value once they do. You go back on ebay or craigslist and you say: hey i’d like to buy an iphone, and so then you buy an iphone 10. You you get it and prices have dropped. So let’s say you were able to sell it for 600. In a year you buy it back uh, you know same exact model, you buy the iphone 10 back for let’s, say 500 and you go back to your buddy and you hand it back to him. You’Re like thanks for letting me borrow your phone for a year. You made a hundred bucks by selling something first that you had to borrow and then buying it back to close out that trade to complete that transaction. This is exactly what is happening with uh with shares when somebody shorts a stock, all they’re doing is borrowing those shares from somebody else who owns them and then they’re selling them then at some point they as far as their expectations go. The stock is going to drop in price they’re, going to buy those shares back from the market and deliver those shares back to the owner and, at any point, the person who who has lent out the shares can request those shares to be returned to them and Uh, the broker, who is kind of the middleman, will go to the person who shorted it and say: hey you’re, being closed out.
The shares that you uh you borrowed are no longer available and so they’re closing them out, and so at any point in time, uh you, you might get uh closed out of your shorts if you’re borrowing them from somebody, especially on a stock where a lot of People are trying to short it now. In the iphone case, let’s say something else happens and uh apple decides we’re no longer going to make any iphones anymore we’re going to make something else and all of a sudden iphones become collectors items and they skyrocket in value. Well, what you’re going to have to do, then, is go and buy an iphone 10 on ebay for let’s, say a thousand dollars and give it back to your buddy, because you still own an iphone and you sold it for 600 bought it for a thousand. You lost 5 400 bucks per iphone same thing with shares. If you short the shares – and you borrow it to sell it and then this the price of the stock goes up for any reason, you’re gon na have to buy that uh that those shares back and then deliver them, and if you bought higher than you sold Whether the buy or the sell comes first or second, if you buy higher than you sell, you lose money if you sell higher than you buy, you make money now. Sometimes, what happens is that there are certain stocks out there that are so widely believed to have to go down in value that uh that the short interest, the number of shares out there, that people have borrowed to sell and that are still waiting to get bought Back to close out the number of borrowed and shortage shares is so high that you end up seeing a short squeeze, develop.
Let’S say the stock is at seven bucks. Everybody and their mother expects it to go to five bucks and everybody shorts it at seven bucks. Well, as it approaches five bucks, everybody who’s short is going to have to buy it at some point to take their profits, so they’re going to buy it let’s say at five dollars: well buying pressure, soaks up the selling pressure and so you’re gon na start. Seeing a lot of buys enter into the market, and so as it approaches five, then it’ll lift off because everybody starts to close out their trades. And then you know some people say i’m going to hang on some people say i’m just going to close out and take what gains. I have but eventually it’s possible that those those buys that new momentum takes the price up a little bit higher and now it’s at eight dollars or nine dollars. And now everybody who is short, the shares, they’re losing money, and so they start to say, hey. I don’t want to lose any more money here so i’m, going to just close out my trade take my losses at eight bucks or nine bucks and all of those people who were short, who have to buy those shares back to close out their trades to deliver. Those shares back to the owner, all of that is actually buying and so more buy orders hitting the market is going to continue to drive that price up and so that’s.
What people are talking about when they say there’s a short squeeze going on in something it’s. When so many people have bet against it that they have to start closing out their trades and that reverses the momentum now sometimes this happens just by natural market mechanics and sometimes a short squeeze develops by intention. If you’re trading in a relatively illiquid or low market cap stock, that you see has a very, very high short interest and you’ve got a lot of money, you can just start hammering buy orders into the market and dumping a couple million dollars a day in orders Into buying this stock, and eventually what will happen is you’re going to squeeze out the person who is short or the the number of people who are short they’re all going to have to start buying back those shares, and that is going to drive the price even Higher and that’s going to allow you to unload the shares that you have bought, as somebody else is buying them to close out their shorts, and so somebody with a lot of capital can force a squeeze to happen if the. If the right market conditions are there. If there’s a low enough uh market cap or low enough liquidity on the stock and if there’s a high enough short interest outstanding on those shares now with gamestop, this is partly what happened except it wasn’t, just one investment bank or one hedge fund. Doing this, it was actually a uh, a network of small retail traders that i kind of kind of went viral among gamers and traders online that there were large institutions that, had you know, massive short positions on gamestop and a lot of small traders like robin hood Traders they went in there and everybody just started buying gamestop understanding that if enough of us little guys start to buy this stock that’s going to force the price up and that’s going to force everybody who’s short to buy it back and that’s going to.
You know close them out of their shorts it’s, going to cause them to lose money for betting against this company that we love gamestop, so that’s a big portion of what contributed to this spike, but that’s, not all there’s. A second thing that has been contributing to the massive skyrocketing price in gamestop right now, and that is delta hedging delta hedging has to do with uh what market makers do to hedge their risk? When traders are trading options now let’s say you go in and you think the stock is going to go up, but you want some leverage you don’t want you don’t have enough. Money to you know, maybe buy as many shares as you want, and so, but you want to be able to capture that full move. So let’s say you buy a call and knowing that you could lose every everything you put into it. But if it goes up, you’re gon na make a lot more than if you had just bought the shares. Well, options are contracts with both a buyer and a seller. Somebody has to be on both sides of that contract, because a call option states that the buyer has the right to buy shares at a certain price, and that means well they’ve had to buy them from somebody right, and so the seller of that call is the One that would deliver those shares the seller is taking on the obligation and the risk saying hey if stock goes up i’m promising that i will sell those shares to you at this given price.
Now, when you go and make a trade, whether it’s for stocks or options or something else you’re, not actually trading with, you know you between just one other person, one other trader, there’s, a middle man called a market maker. Now these market makers, their job, is to provide liquidity in the market, so their job is to go in there and say no matter what? Even if there’s, not a lot of other traders, we’re going to be in here, we’re going to provide volume and we’re going to provide liquidity here so that, yes, it might not be the best price, but at least there’s some price available for somebody. If they want to buy or sell something on this, they make they literally make the market in that security. Now, market makers are not in the game of profiting off of moves on the stocks or the securities that they’re uh, making a market in what their job is is to provide liquidity, and so they don’t care whether it goes up or down they’re the middleman and They’Re taking the spread, and so if you come in and you buy a stock at a hundred dollars, they’re at the same time, they’re pairing your trade up with somebody else who is selling that stock and the other person is selling that stock for 99. So, instead of you guys, both getting 99.50 to trade back and forth with each other market maker is going to take the difference and they’re going to say.
Yes, i will sell you to you, buyer. I will sell to you at 100 bucks and i will buy it from you seller at 99 bucks and i keep the dollar i’m gon na match up those trades i’m gon na keep the dollar and then i stay neutral. I don’t have a position in the stock i’m, not short, i’m, not long i’m, just matching up buyers and sellers and so that’s how they get compensated and it’s it’s. Never that big of a spread i mean. Sometimes it is on options, but usually it’s. A relatively tight spread and so they’re making half a cent one cent two cents on every trade and that’s their compensation for making sure that any security has some sort of liquidity in it, so that, if somebody wants to trade it they can now, you might be Thinking: okay! Well, then, if, if there’s, nobody on the other side of the trade, though, if everybody’s coming in and there are no traders, no investors who want to sell calls, everybody wants to buy calls well. Who is the market maker matching up the other side of the trade with because they’re there to make a market to make sure that, at some price, somebody’s able to trade if they want to what? If there’s nobody on the other side that wants to sell calls? What, then, this is where delta hedging comes in, because the market maker will still provide the liquidity they’ll still make sure that if you want to buy a call, you can buy a call, even though everybody and their mother is buying calls on this.
And so, if the market maker sells you a call, that means you bought it. That means they’re short that call they’ve sold you that call so in that contract they’ve promised to deliver shares to you at a specific price and so what they have to do to hedge themselves to make sure that they don’t have to buy them. You know in a week or two weeks at a much higher price. They have to buy those shares right now so that they have those shares to deliver just in case they have some losses on the call or have to deliver, because if the stock price goes up, they’re losing on that call because you’re gaining it’s a it’s, a Zero sum game: every dollar they make from buying the call you’re as the market maker is uh you, as the market maker, are losing on those calls, and so in order to offset that they’re gon na buy enough shares. They’Re gon na buy the number of shares that they need so that, if whatever they lose on the call they’re making on the shares – and then they also have them to deliver if they need to so here’s what’s important here, if every trader out there starts buying Calls you only have to commit a little bit of money to buy a call that represents the number of shares that it or the underlying shares, which is 100 shares, and so, if all of the traders out there are committing hundreds of thousands and millions and tens Of millions of dollars to buying calls over and over and over on a single stock, that means all of the market makers out.
There are having to actually buy the stock in order to hedge their position, so this is the biggest contributing factor to the rise in the stock price of gamestop, because people are out there buying calls to speculate on the stock price going up and that’s actually forcing Market makers to buy shares which forces the price up. Now i made a video about this before on the actual stock market. This happened with the actual stock market and softbank who’s, a big guy asian investment company. Some news came out a couple months ago that they were doing this, that they were pumping a ton of money into buying calls on stocks to drive up the stock market, because they knew that if enough money was coming in to make the volume of call buying Rise to uh to a portion to a proportionate level where it was outpacing by a large margin. The number of sellers of those options that the market makers would have to hedge by actually buying the stock. And then it would start forcing the price of the stock. Up and so as violent of a rise as the spike in gamestop stock prices have been. We know that it was forced to happen through a combination of a short squeeze and delta hedging, which means that it can reverse itself at any moment, and nobody knows the future. But judging by today’s uh price action, it looks like the top of this bubble might be in now.
Who knows? We could consolidate here and have one or two or a couple? More giant pops, but ultimately, especially because this was purely driven by these technical mechanical market functions and not by anything about the company, not by anything that you know it’s, not like people believe in the company more now than they did before. It was just driven purely by these. These market mechanics there’s very good chance that the stock price falls all the way back down to exactly where it was before, potentially even lower, especially once this momentum reverses itself, because the same thing can happen on the downside as it starts to fall. If people start buying puts instead of calls a put, is the the opposite of a call, and so that will force market makers to start shorting the stock selling the stock in order to hedge, their short put positions, and that will force the stock price down. Just as fast as it has risen so far, so that’s the explanation of the crazy story behind the recent spike in gamestop. I hope you enjoyed it and if you want to get in on the action and speculate a little bit with a little bit of your money, and you have no idea how to trade options, go ahead and check out my options. Foundations course it’s for the person who has a little bit of experience, investing but wants to take their investing to the next level and dip their toes into options, it’s all about the fundamentals and the foundations of the terminology and the mechanics and how to trade.