Academic Department: Finance

Course: Sem. Alternative Investment

Professor: Elizabeth Tantalean Valdivieso
Semester: 2021 II

Case N° 01:

Topic Hedge Funds

The GameStop Short Squeeze

Group N° 7

Tacunan Flores, Lorena Beatriz

Tantalean Salas, Xiomara
Taya Chau, Juan Manuel
Torres Vera, July Carolina de Jesús
Valladares Perez, Julio Gonzalo

September 2021
Questions:
1. Why do you think GameStop was considered attractive for short selling by
hedge fund managers like Melvin Capital?
It was attractive for short selling due to the fact that it still relied on physical
sales in an industry which was quickly moving toward the digital world. This
resulted in a declining business, which was attractive for hedge funds to profit
off by short selling.
2. What is a short squeeze? How it may affect the strategy of short selling
performed by a hedge fund?
When the hedge fund is convinced of the negative perspective on the stock,
they apply the strategy of short selling. They’ll sell borrowed stocks, and then
buy it at a lower price. However, when the price starts to rise and they continue
in a short position, they must buy the shares at a higher price to cover their
position of limited liquidity. Also, they are obligated to buy it because they need
to return the shares to the broker. This is known as a “short squeeze”.

Besides, if other hedge funds are in the same short position, thus all will start
closing out their position at the same time. This puts a lot of upward pressure on
the stock’s price because of the increased demand and it could result in big
losses for the hedge funds that apply short sells. So, at the end they’ll pay a
higher price for the shares than the price they had sold them for.

3. How the short squeeze in GameStop was originated? Which trading

platforms were used?
As detailed in the article "Counter-Hegemonic Finance: The Gamestop Short
Squeeze", before buying GameStop shares, Citron Research, a major hedge
fund, had commented that such shares would fall. After speculating that, Citron
Research and Melvin Capital were aggressively short-positioned. However, they
did not count on a group of small investors that agreed to increase the price of
GameStop and, in this way, to damage these hedge funds. As mentioned in the
article, one of the reasons why this group of investors decided to join is the
feeling of resentment towards the big giants of Wall Street. The resentment
arose because, in both Global Financial Crisis 2008 and 2020, a
disproportionate amount of bailout stimulus went to the 1% coffers rather than
to the relief of the American masses. In addition, not a single American banker
was directly jailed for misconduct in times of crisis. For that reason, the idea
was to join forces of the small ones so that the big investors feel frustrated at
least for a moment. This pain that they tried to inflict is “a short squeeze”. Also,
it is said that the fight was David against Goliath's struggle of counter-
hegemonic natures underway.
This group of small investors coordinates their strategy through Reddit which is
a type of social network that is like forums where people talk about particular
topics, in this case, investments. The group of investors belonged to the r /
wallstreetbets subforum. Among the main platforms used is Robinhood.
This case leads us to reflect on the importance of behavioral finance,
specifically we refer to the herd effect as many investors bought GameStop
shares because others did too. It also highlights the power of social networks in
finance, which have enabled the creation of the famous "meme stocks".
Moreover, all this has been possible because digital investment platforms allow
access to the market from small amounts.
4. Do you think short-selling can destroy a company on its own?
A suppressed stock price, generated by short-selling, does affect their ongoing
ability to obtain financing, and raise capital through selling stock. In other words,
there is a reduction in the market capitalization of a company and it can divert
loans and issuance of preferred shares. It can definitely hurt a bit in the near
short-term, but low share price alone won’t destroy a company.
The bankruptcy or destruction of a company is more linked to its management,
if it’s being carried out correctly, and not only because of short-selling. In fact,
short-selling provides a company with guaranteed buyers, after the short
position. Depends too on whether the buyers have a good outlook on the
company, the expectations. These along with guaranteed buyers will drive
prices up, that’s a whole buying pressure in the market.
Relevant factors that can destroy companies are getting a load of too much
debt, not being innovative enough, not offering actually good services, or
services that people continue to want. In the big picture because you’re running
a well-run company, you will have many buyers. An example of this is Tesla that
is vastly benefiting from shorts.
5. Do you think short selling should be banned?
Some market observers associate short selling with a high-risk speculative
behavior that increases the market risk for publicly traded companies calling for
more disclosure or bans on short selling. However, in contrast, others argue
that short sellers perform valuable functions by ferreting out fraud. During the
volatile trading of GameStop stocks, they were restricted from trading by
several retail brokers. Citing its need to comply with both SEC net capital
requirements and clearing deposits. Nevertheless, this action also raised the
concern that retail investors were being cut off from market access while larger
institutional players were able to continue trading.
In this sense, we believe that short selling should not be banned as it is a
crucial part of the market efficiency. Short selling is fundamental to ensure
correct market prices, which incorporate more real time information so that
prices reflect the firm´s true value. Helping to ensure that the market is fair for
investors. Furthermore, short selling is not manipulative per se since there is
regulatory scrutiny to prevent it and as of now there is not enough evidence to
sustained this claim at least in a systematic basis.