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Owen faculty reflect on GameStop stock price surge and the future of community retail investing

by Feb. 23, 2021, 10:29 AM

Faculty at Vanderbilt Owen Graduate School of Management are drawing important lessons from the fascinating and unlikely saga of the GameStop stock “short squeeze” that captured the attention of the world in late January. The episode, in which the seemingly failing retailer’s share price soared by hundreds of dollars only to fall just as spectacularly within two weeks’ time, pitted establishment Wall Streeters against a Reddit-organized group of lay investors using the aptly named Robinhood trading app.

Although the GameStop story may be an anomaly, it has had big ripple effects, prompting an SEC investigation into trading platform governance and the regulation of investment communities. As the investigation unfolds, Jesse Blocher and Joshua White, both assistant professors of finance at the Owen School, caution retail investors against taking large market risks in the name of “making a point” and advocate for common-sense reforms to protect publicly traded companies and investors.

Jesse A. Blocher (Vanderbilt University)
Joshua White (Vanderbilt University)

According to Blocher and White, the coordination required to pull off a short squeeze—the rapid increase of a stock price based on nonfundamental market factors—is incredibly complex. They say that the GameStop story represents the first true short squeeze successfully led by a group of retail investors.

Blocher points out that there was a unique confluence of factors during the GameStop stock surge that may not exist in future retail investing opportunities. For one, retail investors were able to buy call options at zero cost, layering what is known as a gamma squeeze on top of the short sell. In this instance, as GameStop’s stock price rose, it attracted even more short-selling investors who were hoping to profit once the bubble burst and the stock price inevitably fell.

Moreover, the market was unable to take a counter-cyclical position and sell shares of GameStop, which would have leveled the stock price sooner. “When other investors saw GME jump to $400, they certainly saw that stocks were badly overpriced,” Blocher said.

Funds typically profit off a rapid stock increase by buying “put options.” In a put option, the Option Market Maker must hedge the sale by shorting the underlying stock. In 2008, however, the SEC removed the so-called OMM Exemption where OMMs could avoid borrowing the stock for that short sale. Blocher explored this potential phenomenon in his research published by the Owen School.

“In the GameStop saga, there was a combination of upward price pressure through the gamma squeeze and short squeeze, combined with an utter lack of any downward counterbalancing,” Blocher said. “Since short sellers were getting blown up, lending fees were super expensive, and the options market was not useful for circumventing any of this.”

As the SEC begins its investigation, White believes the first step for protecting investors is analyzing the impact and behaviors of community investing apps like Robinhood. As GameStop’s stock price ballooned to unprecedented levels and the cost to the hedge funds that shorted the stock became apparent, Robinhood restricted the trading of GameStop and other stocks highlighted in the r/WallStreetBets Reddit thread.

“One of the big questions people ask is whether this was market manipulation. I think it will be tough to make the case that chatter on an anonymous forum is manipulation, especially if the statements are not false,” said White, a former SEC economist. He does, however, believe the SEC will investigate whether any members of the r/WallStreetBets community have ties to hedge funds.

Ultimately, Blocher and White advocate for steps that will protect retail investors.

“There is still a lot of latent anger at Wall Street that can make people engage in potentially self-harming investments,” Blocher said, noting that many Wall Street funds actually benefited from the GameStop scenario.

“My research published by the SEC,” added White, “shows that those who end up being hurt the most from stock promotions are not the speculative investors that enter early in the scheme but the vulnerable investors, particularly older and less educated individuals, who enter the stock near the peak of a pump-and-dump scheme and then lose almost everything when the stock price crashes.”

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