Home Current Events GameStop Is the Poster Child: What’s Up with Wall Street?
GameStop Is the Poster Child: What’s Up with Wall Street?

GameStop Is the Poster Child: What’s Up with Wall Street?

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One of the best summaries that I read of the increase in value of GameStop stock last week was from Wall Street Journal reporter Jason Zweig. Mr. Zweig’s was by no means the only article written about the subject. I found nine GameStop articles published over the past three days on Forbes.com and assume many more are on the Wall Street Journal site.

For the uninitiated, GameStop bills itself as the world’s largest retail gaming destination for Xbox One X, PlayStation 4, and Nintendo Switch games, systems, consoles, and accessories. Unfortunately, the popularity of digital gaming (83% of the market in 2018) has caused GameStop stores to lose a lot of business. The company has lost so much business that it closed 321 stores in 2019, pre-pandemic.

Naturally, with the company’s business model impacted by the rising popularity of digital game downloads and the pandemic’s social distancing orders in 2020 triggering the closures of GameStop retail stores in many states, GameStop’s financial woes have negatively impacted the value of its stock.

If a company’s stock value declines and its future earnings prospects are not good, the situation could trigger investors who bet on the future decline of the stock price by signing contracts for selling a specified amount of the stock at a certain price within a certain timeframe. The contract becomes the option agreement that investors may choose to purchase. When an investor purchases a “put option”, they pay a specified amount for that contract.

If the stock price continues to decline, the buyers of the put options make money. If the stock price remains the same or increases, they usually lose the money they paid to purchase the option.

But if the stock price increases, the maker of the put option contract may be in a vulnerable position because the contract requires them to deliver a certain number of shares at a price that is below where the stock is selling. Depending on the contract (not secured by holding any shares vs. holding a certain percentage of the shares in the contract), the obligor to the contract may be required to put up additional collateral or cash if the contract is in a loss position (underwater) as the contract nears its expiration.

An investor who participates in Reddit’s r/WallStreetBets investment forum noticed that the total number of shares of GameStop stock that had been shorted exceeded the entire amount of previously issued and unretired GameStop stock. He suggested that the investors in the forum buy GameStop stock with the hope that the increased purchase activity would drive up the price of the stock and create a market condition called a “short squeeze.”

A short squeeze occurs whenever the price and demand for a stock is rising, and a major tranche of put options are coming due. Because the contract calls for the delivery of some stock (contract specific), the obligor under the contracts goes into the hot market to try to buy enough stock to cover the contract. That increased activity usually increases the price of the stock because it increases the demand for that particular stock.

The purchases of GameStop stock by the individual members of the Reddit investment forum triggered a huge demand for the stock and a rise in the share price. Within two days, the stock was the most heavily traded stock in the world. The idea’s originator claims to have turned a $50,000 investment into a $40 million profit.

One of the hedge funds that participated in a substantial number of the put options (or could have been an obligor on the options or a short seller) on GameStop stock, Melvin Capital, had to get a $2.75 billion investment in order to meet its obligations due to the stock’s increase in value. A startup online brokerage firm that offers commission-free trades, Robinhood, had to stop investor trading in GameStop stock until it could get a $1 billion cash infusion to cover the settlement volume of trades going through its accounts (note, as of today, Robinhood announced that it received an additional cash infusion of $2.4 billion).

Even before Robinhood stopped trading in GameStop stock, the huge increase in trading volume and extreme increase in GameStop’s stock price (up 500 percent), had triggered the attention of politicians and regulators. Two politicians whose political views are at opposite ends of the political spectrum, Sen. Elizabeth Warren and Sen. Ted Cruz, called for the brokerages who suspended trading to resume trading in GameStop stock.

Sen. Warren, who led the Consumer Financial Protection Bureau (CFSB) before she became a senator, has called for the Securities and Exchange Commission (SEC) to investigate the activities of the “hedge funds, private equity firms, and wealthy investors who have treated the stock market like their own personal casino while everyone else pays the price.”

It’s too soon to know the outcome of the GameStop story. In addition to GameStop, there were three other companies (AMC Entertainment Holdings, iRobot Corporation, and BlackBerry Ltd.) whose stock prices surged last week due to a similar situation. In that case, individual investors purchased heavily shorted stocks, and obligors under the contracts had to purchase shares in the market to cover their contract requirements.

I am sure that the SEC will investigate the situation and that Congress will conduct hearings as well. Today, the markets will open again for trading and we’ll see what happens with the stocks I mentioned. Since most put contracts have an end date near the month, there may be a period of lower trading volume until the next tranche of contracts near expiration.

Regardless of what you believe about GameStop as a company, the stock is trading much higher than the fundamental values indicate that it should trade. Eventually, the price will come down.

There are many opinions about the GameStop situation. Even among educated and experienced financial professionals, the opinions can vary widely.

As someone who has been a public company Chief Financial Officer (CFO) and Chief Executive Officer (CEO), I am very familiar with the nuances of stock value fluctuations as it relates to trading volume, demand for stock, and the volume of put and call options on a company’s stock. It’s my intention to discuss some of my personal opinions as well as report on the opinions of others in a follow-up article or two. At the same time, I don’t claim to be an option expert, nor do I believe that my brief explanations in order to discuss this topic cover the wide variety of options that are available in the market. For that reason, I hope to have a follow-up guest post with a more technical explanation than mine in this post. As always, your comments are welcome.

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Wally Boston Dr. Wallace E. Boston was appointed President and Chief Executive Officer of American Public University System (APUS) and its parent company, American Public Education, Inc. (APEI) in July 2004. He joined APUS as its Executive Vice President and Chief Financial Officer in 2002. In September 2019, Dr. Boston retired as CEO of APEI and retired as APUS President in August 2020. Dr. Boston guided APUS through its successful initial accreditation with the Higher Learning Commission of the North Central Association in 2006 and ten-year reaccreditation in 2011. In November 2007, he led APEI to an initial public offering on the NASDAQ Exchange. For four years from 2009 through 2012, APEI was ranked in Forbes' Top 10 list of America's Best Small Public Companies. During his tenure as president, APUS grew to over 85,000 students, 200 degree and certificate programs, and approximately 100,000 alumni. While serving as APEI CEO and APUS President, Dr. Boston was a board member of APEI, APUS, Hondros College of Nursing, and Fidelis, Inc. Dr. Boston continues to serve as a member of the Board of Advisors of the National Institute for Learning Outcomes Assessment (NILOA), a member of the Board of Overseers of the University of Pennsylvania’s Graduate School of Education, and as a member of the board of New Horizons Worldwide. He has authored and co-authored papers on the topic of online post-secondary student retention, and is a frequent speaker on the impact of technology on higher education. Dr. Boston is a past Treasurer of the Board of Trustees of the McDonogh School, a private K-12 school in Baltimore. In his career prior to APEI and APUS, Dr. Boston served as either CFO, COO, or CEO of Meridian Healthcare, Manor Healthcare, Neighborcare Pharmacies, and Sun Healthcare Group. Dr. Boston is a Certified Public Accountant, Certified Management Accountant, and Chartered Global Management Accountant. He earned an A.B. degree in History from Duke University, an MBA in Marketing and Accounting from Tulane University’s Freeman School of Business Administration, and a Doctorate in Higher Education Management from the University of Pennsylvania’s Graduate School of Education. In 2008, the Board of Trustees of APUS awarded him a Doctorate in Business Administration, honoris causa, and, in April 2017, also bestowed him with the title President Emeritus. In August 2020, the Board of Trustees of APUS appointed him Trustee Emeritus. In November 2020, the Board of Trustees announced that the APUS School of Business would be renamed the Dr. Wallace E Boston School of Business in recognition of Dr. Boston's service to the university. Dr. Boston lives with his family in Austin, Texas.

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