Gather ‘round, my friends. It’s story time.
Once upon a time, a few days ago, the short interest on Game Stop (GME) was 140% and the shares hit $490. It began to experience a short squeeze.
But what does this mean??
Let’s think about it in terms of a drug dealer… we’ll call our hypothetical drug dealer, Melvin Citadel, off the character’s inspiration.
Melvin sells MDMA. There’s a big concert coming up. Everyone wants to be like Miley, at the concert, dancing with molly.
“So, la-da-di-da-di, we like to party… and we can’t stop, and we won’t stop.”
Melvin borrows 1400 “pills” to return later and pay interest on them, even though only 1000 exist. How can he do this?
Melvin never actually holds the MDMA—he isn’t about the drug life. He’s a businessman. You can’t get high on your own supply. He borrows the pills and will return them when they’re cheaper in the future. He then pockets the change.
He has a plan — if he can sell the pills for cheaper and the local drug dealer goes out of business, then he will make a much better return on his investment.
So that’s what he does, or tries to do.
Trying to drive the friendly neighborhood drug dealer, Game Stop, out of business, Melvin drove the price of the MDMA down to $4. Melvin secretly hopes that the price of MDMA goes down to $0.
Remember, there’s only 1000 MDMA pills.
Game Stop sees what’s happening, however, and isn’t going to go down without a fight. Game Stop buys 100 MDMA pills from Melvin, all they can afford. Their friends at Wall Street Bets like MDMA too, and they buy 100 MDMA pills. Now there are only 800 MDMA pills left on the streets.
Another big investor, came in and gobbled up 300 MDMA pills. Now, there are only 500 pills left on the streets, but Melvin still need to return 1400 pills.
The price of MDMA skyrockets because the big investor decides to start selling MDMA online. Now, everyone is interested in MDMA pills.
There’s always been options available on MDMA pills. When the price starts to go up, higher option prices start being written. When the higher option prices are bought, the people (banks, etc) who write the options buy pills in case the options are exercised. This is called gamma hedging. This causes the price of the pills to go up even higher.
Someone at Wall Street Bets realized the situation that Melvin was in and the Reddit army buys more MDMA pills to fuck with Melvin. They like their neighborhood dealer, Game Stop. They don’t want him to go out of business. They don’t like Melvin. Melvin has been getting away with this kind of stuff for ages—at the expense of many of their families. The Reddit army buy 200 more pills.
The price of the MDMA pill rises from $4 to over $400, because demand far outweighed supply.
As the supply of MDMA on the streets dwindled, Melvin tried his hardest to manipulate the price of the drug.
See, Melvin and his friends invested in Robinhood, a marketplace where MDMA is sold.
Robinhood customers buy and sell drugs, as a gateway between regular people and Market Makers like Melvin. On RH, the trades don’t “settle” or “close” until 2 days later. Depending on the net of buys/sells, RH is on the hook to pay or receive money to cover the buys and sells of the drugs. That’s called credit risk. Gap risk measure is, then, their exposure to interest rate risk.
RH decided to only allow people to sell their MDMA vs buy more MDMA, which of course, caused the price to plummet d/t artificially decreased demand in order to decrease their gap risk measure. RH’s CEO got on national television and admitted to doing so to decrease the price of MDMA back to what, he thinks, is normal levels.
This is illegal.
There are rumors that Melvin encouraged RH to do this, because Melvin’s debts are starting to get called in and he is worried about paying for it.
Because Melvin sold more MDMA pills than they are on the market, the people who own MDMA pills get to determine their price. Melvin knows that soon he will have to pay any price to return the pills he borrowed.
Legend says, the price could go up to $10,000… as long as you exercise the same caution as Melvin: never get high on your own supply.