A few days back, I received a screenshot from a friend who is in the US - the stock gained more than 700% in a week. I was astonished, how can stock rise 400% in less than a week - the first impression was the company must have declared outstanding results or announced some expansion plans. Still, never have heard of such numbers. I was curious, hope you are too!
Interestingly, the rise in stock price has nothing to do with the company or its business. GameStop is a retail gaming company - it has physical stores that offer new and pre-owned video gaming consoles, accessories and video game titles. The company has been struggling since 2016 and there has been news of its filing for bankruptcy on a number of occasions. For most of 2020, the stock was trading below $10. On 28 January 2021, the stock crossed $450. How?
The game of short selling
Before we get to the how, let us understand what is short selling. There are two ways to make wealth - One is a traditional way where you invest in good companies and wait for them to grow. You buy the stock and wait for the price to increase over time i.e long stocks. There are a few people who make money by doing the reverse. They first sell the stock at the current price and wait for the stock price to fall. Once it falls, they buy the stocks and square off (you buy N shares and when you sell them, you square off your position i.e complete the cycle) their position - they make money through short selling.
Understand this point - When you long stocks, the maximum amount you can lose is the cost of the share i.e if you bought 10 shares of Rs 100 each, the maximum you can lose is Rs 1000. When you short stocks, there is no limit to your loss. You sold the stock at Rs 100 (to buy it later at a lower price) but if it increases, the price of the stock can go anywhere - so your potential loss can be infinite (theoretically).
One more term before we get to how - Stock Lending and Borrowing. When you short stocks, you first sell the stocks, right? How you sell something which you don't own. You borrow it from some lender (in return for some fees) and sell it in the market. You then buy the stock when the price goes down and return the stock to the lender. This process is known as Stock Lending and Borrowing.
How and why GameStop's share price increased?
Some Hedge funds in the US were continuously short selling the GameStop shares. The volume was so high that they have sold more shares than what was floating in the market. How is it possible? A percentage of stocks are with promoters and some institutional investors that don’t float in the market, as per reports, even those were lent and shorted. This news came in public and a group of retail investors known as 'Wallstreetbets' united to make the most of the situation. In unison, they started buying the shares which pushed the price of the share higher. Since the hedge funds had sold the stock at a lower price and they had to buy the stocks even though the price was increasing, it created additional demand and increased the price further.
On the other hand, retail investors had returns you cannot even dream of. Even a lot of investors from India invested in the stock and got excellent returns in a few days.
Can this happen in India for any stock?
From the above discussion, it is clear to get to this scenario, there has to be a concept of Stock Lending and Borrowing (SLB) in the market. Interestingly, SLB was introduced in the Indian market way back in 2008. However, it is not popular. Even popular trading platform like Zerodha is not offering this option. One of the reasons why brokers can't lend the shares to you (which is done in the US) for short selling is because in India the stocks are not with brokers but with central depositories - NSDL and CDSL. In the US, the stocks are deposited with brokers while only authorized bodies can lend in India.
A lot of people don't go into lending because "the lender’s income qualifies as ‘income from other sources’, so people lending will have to file tax returns using ITR3 and may need audits. Whenever there is a corporate action like rights and bonus issues, there is a forced closeout of the position", mentioned Nithin Kamath, co-founder of Zerodha recently.
Because of the above reasons, a GameStop-like situation won’t happen in India. As an investor, you should stay away from such stocks. As per experts, the price of GameStop is going to come back from where it all started.
Stocklylab helps you in picking only quality stocks through its fundamental analysis algorithm and fundamentals don’t lie.