I found this on reddit and now I'm understanding
*It's long and it's about stocks and Gamestop*
Great information though
Hopefully this is helpful. I work in the stock market and my little brother asked me to explain what was going on. Here was my response:
Let’s say GameStop has 100 shares outstanding currently trading @ $20 per share (so if you own 1 share, you own 1%, 25 shares = 25% and so on)
That’s it. There are only 100 shares of GameStop. Throughout the day people are constantly buying and selling these shares for one reason or another (that’s why the stock price moves up and down constantly)
Now, typically when you think about making money in the stock market you typically think “buy low, sell high” 📈. In other words, buying Amazon when it was cheap, and now it’s worth 💰 💰 💰. In this case you would be speculating that the stock price of Amazon will go up ⬆️ in the future
- *fun industry term: you are “bull-ish”*
Here is where the short selling comes into play.
Let’s pretend You have a hedge fund. Alec’s hedge fund manager looks at GME (GameStop) and says “I think GME is over valued, it really should only be trading at $15 per share, not $20 🤔 “
In this situation, He is speculating that in the near future, the GME stock price will go down (to $15).
- *another fun industry term; he would be “bear-ish” on GME*
Now since the hedge fund manager thinks GME’s stock price will go down, He is going to try to make money on that guess by short selling (shorting) the stock.
To short the stock The manager is going to *borrow* some shares from someone else, bob, and sell them at the current market price (which is $20).
Let’s say he borrows 10 shares (total of only 100 remember) and sells them at the New York stock exchange for $20. He made $200 ($20 x 10 shares)
A while later, GMEs stock price suddenly dips (fun industry term: “down ticks”). It is now trading at $15.
Alec’s hedge fund manager was right! now don’t forget, we borrowed the shares from somebody else so we have to give those back. Alec’s hedge fund manager goes to the New York stock exchange and buys 10 shares @ $15 and returns those to the lender.
Alec’s hedge fund made $50 on that trade total (this is called “PnL”).
So the full life cycle:
- *Borrowed 10 shares from “bob”*
- *Sold 10 @ $20 in the market*
- *Bought 10 @ $15 in the market*
- *Returned 10 shares to “bob”*
Total profit = (10 x $20) - (10 x $15)
Okay.... so now onto what is actually happening with GameStop.
Let’s keep the example the same. GameStop has 100 total shares outstanding.
Now a bunch of hedge fund managers all think the exact thing that Alec’s hedge fund manager thought so they all short the stock with the expectation that the price will “downtick” in the future.
Here’s the thing.... someone on Reddit pointed out that despite the fact that GameStop only has 100 shares available at any given time, there were actually 125 shares on loan to cover short sales.
I know this part is confusing, which it should be. That doesn’t make sense mathematically. How can you have more shares loaned out than available? I’m going to gloss over those details and just say that it is possible, and does happen on occasion.
Now when you have a stock that is over shorted like this, you have one major risk, which is called a “gamma/short squeeze” . It does not occur often.
In a gamma/short squeeze, there are more shares loaned out than available. That is because all of those hedge fund managers thought the price would go down and got greedy and tried to make as much 💰 as possible and over borrowed assuming they would be able to cover it. But, someone pointed that out on Reddit, and was able to get that information to go viral. Now with all of these new people buying the stock, it forced the stock price up, very quickly (supply and demand).
Just like in the example, these hedge fund managers had to return the shares to the lender... the problem is, the stock price has gone up so much that if they have to “close their position” they’ll lose a fortune.
- *Example: I sold 10 @ $20 = $200*
Instead of going down; the stock price went up to $400. I have to return the stock to the lender and the only way to do it is to go buy it back. So:
- *I buy 10 @ $400 = $4,000*
- *PnL = +$200 - $4,000*
instead of making money; I lost $3,800.
This is basically what is happening with GME on a much bigger scale
Edit 1:
Lots of people asking about the “loan”. It’s not really a loan in the way that you’re thinking. When you execute an order to sell a share, you are required to Mark it as either “long” or “short”. What this really means is, do you “have” the stock right now in your bank account, or are you “able” to get it easily. So theoretically, everyone could be marking their orders as short sales, assuming the shares are easy to borrow and readily available, except, as the price goes up, people panic and start buying them all up and there aren’t enough to go around. This in turn drives the price up further. Hence the “squeeeeeeeze”
Typical settlement of a trade occurs t+2. In other words, you’re required to deliver the shares you sold short to the counter party within two business days of execution
Edit 2:
for those asking about option expiration:
An option as like a coupon. It gives the coupon holder the right to buy or sell stock, at a given price, on a given date.
Think about it this way. If I think that the stock price of GME is going to go up in the near future, I can buy a coupon (technically a call option) that gives me the right to purchase the stock for a set price at a later date. So if GME is @ $20, I may buy a call option that gives me the right to buy GME stock for $20 per share exactly one month from now (expiration). The idea is that within that time frame; the gme stock price will increase, thereby making my coupon valuable because it allows the owner to buy at a discount.
On the other side, you have someone who “writes” the contract. Essentially sells you the coupon. Let’s say GameStop is trading at $20, and you buy that $20 coupon. Well now, GameStop is trading at $400. So if your expiration is tomorrow you can “exercise” it, and the writer is required to deliver your shares for the agreed upon price, $20. To do that, they’ll probably have to go out and buy it at these exorbitant prices
Great information though
Hopefully this is helpful. I work in the stock market and my little brother asked me to explain what was going on. Here was my response:
Let’s say GameStop has 100 shares outstanding currently trading @ $20 per share (so if you own 1 share, you own 1%, 25 shares = 25% and so on)
That’s it. There are only 100 shares of GameStop. Throughout the day people are constantly buying and selling these shares for one reason or another (that’s why the stock price moves up and down constantly)
Now, typically when you think about making money in the stock market you typically think “buy low, sell high” 📈. In other words, buying Amazon when it was cheap, and now it’s worth 💰 💰 💰. In this case you would be speculating that the stock price of Amazon will go up ⬆️ in the future
- *fun industry term: you are “bull-ish”*
Here is where the short selling comes into play.
Let’s pretend You have a hedge fund. Alec’s hedge fund manager looks at GME (GameStop) and says “I think GME is over valued, it really should only be trading at $15 per share, not $20 🤔 “
In this situation, He is speculating that in the near future, the GME stock price will go down (to $15).
- *another fun industry term; he would be “bear-ish” on GME*
Now since the hedge fund manager thinks GME’s stock price will go down, He is going to try to make money on that guess by short selling (shorting) the stock.
To short the stock The manager is going to *borrow* some shares from someone else, bob, and sell them at the current market price (which is $20).
Let’s say he borrows 10 shares (total of only 100 remember) and sells them at the New York stock exchange for $20. He made $200 ($20 x 10 shares)
A while later, GMEs stock price suddenly dips (fun industry term: “down ticks”). It is now trading at $15.
Alec’s hedge fund manager was right! now don’t forget, we borrowed the shares from somebody else so we have to give those back. Alec’s hedge fund manager goes to the New York stock exchange and buys 10 shares @ $15 and returns those to the lender.
Alec’s hedge fund made $50 on that trade total (this is called “PnL”).
So the full life cycle:
- *Borrowed 10 shares from “bob”*
- *Sold 10 @ $20 in the market*
- *Bought 10 @ $15 in the market*
- *Returned 10 shares to “bob”*
Total profit = (10 x $20) - (10 x $15)
Okay.... so now onto what is actually happening with GameStop.
Let’s keep the example the same. GameStop has 100 total shares outstanding.
Now a bunch of hedge fund managers all think the exact thing that Alec’s hedge fund manager thought so they all short the stock with the expectation that the price will “downtick” in the future.
Here’s the thing.... someone on Reddit pointed out that despite the fact that GameStop only has 100 shares available at any given time, there were actually 125 shares on loan to cover short sales.
I know this part is confusing, which it should be. That doesn’t make sense mathematically. How can you have more shares loaned out than available? I’m going to gloss over those details and just say that it is possible, and does happen on occasion.
Now when you have a stock that is over shorted like this, you have one major risk, which is called a “gamma/short squeeze” . It does not occur often.
In a gamma/short squeeze, there are more shares loaned out than available. That is because all of those hedge fund managers thought the price would go down and got greedy and tried to make as much 💰 as possible and over borrowed assuming they would be able to cover it. But, someone pointed that out on Reddit, and was able to get that information to go viral. Now with all of these new people buying the stock, it forced the stock price up, very quickly (supply and demand).
Just like in the example, these hedge fund managers had to return the shares to the lender... the problem is, the stock price has gone up so much that if they have to “close their position” they’ll lose a fortune.
- *Example: I sold 10 @ $20 = $200*
Instead of going down; the stock price went up to $400. I have to return the stock to the lender and the only way to do it is to go buy it back. So:
- *I buy 10 @ $400 = $4,000*
- *PnL = +$200 - $4,000*
instead of making money; I lost $3,800.
This is basically what is happening with GME on a much bigger scale
Edit 1:
Lots of people asking about the “loan”. It’s not really a loan in the way that you’re thinking. When you execute an order to sell a share, you are required to Mark it as either “long” or “short”. What this really means is, do you “have” the stock right now in your bank account, or are you “able” to get it easily. So theoretically, everyone could be marking their orders as short sales, assuming the shares are easy to borrow and readily available, except, as the price goes up, people panic and start buying them all up and there aren’t enough to go around. This in turn drives the price up further. Hence the “squeeeeeeeze”
Typical settlement of a trade occurs t+2. In other words, you’re required to deliver the shares you sold short to the counter party within two business days of execution
Edit 2:
for those asking about option expiration:
An option as like a coupon. It gives the coupon holder the right to buy or sell stock, at a given price, on a given date.
Think about it this way. If I think that the stock price of GME is going to go up in the near future, I can buy a coupon (technically a call option) that gives me the right to purchase the stock for a set price at a later date. So if GME is @ $20, I may buy a call option that gives me the right to buy GME stock for $20 per share exactly one month from now (expiration). The idea is that within that time frame; the gme stock price will increase, thereby making my coupon valuable because it allows the owner to buy at a discount.
On the other side, you have someone who “writes” the contract. Essentially sells you the coupon. Let’s say GameStop is trading at $20, and you buy that $20 coupon. Well now, GameStop is trading at $400. So if your expiration is tomorrow you can “exercise” it, and the writer is required to deliver your shares for the agreed upon price, $20. To do that, they’ll probably have to go out and buy it at these exorbitant prices
