You may have heard the term “short squeeze” a lot over the past few days. That is because of a rare win by David (small retail investors) against Goliath (large hedge funds in the battle for GameStop float).
Excessive household cash piles and healthy balance sheets are encouraging US investors to take on a bit of risk and try their luck on risk assets. One notable evidence of this exuberance was the GameStop saga where several Reddit users (mostly small investors) ganged up against large short-sellers and piled into GameStop shares resulting in a scenario known as a short squeeze – when a stock or other asset price jumps sharply higher, forcing traders who had borrowed and sold the stock betting that its price would fall, to buy it to cut their losses.
As the price for GameStop shares popped, hedge funds were hamstrung forcing them to buy more GameStop shares adding to the upside momentum. A Gamma squeeze in the derivative market also added extra legs to the uphill run in the shares. In the options market, the market maker would have sold options to investors who expect the share price to rise above prevailing levels. On a balance of probabilities, the market maker will have to buy a few shares in the market to hedge his position. Instances where the share prices rally, the market maker is forced to increase the hedged position by purchasing more shares in the market, which eventually adds impetus to the upside momentum.
This saw GameStop’s closing price spiking to a high of $347.51/share on a little volume on the 27th of February 2021 from below R20/share at the beginning of the year.
The stock has since retraced 84% of its value from the peak, and it seems to be on track to be one of the swiftest retracements.