In a David and Goliath style battle, there was much going on in the US markets via the Reddit forum r/WallStreetBets that were trying to beat the hedge fund Melvin Capital by purchasing all the shares in GameStop, a stock that the hedge fund was short on. The idea of short selling may be confusing, so we sat down with Peter Switzer and Paul Rickard, who’ve both had long careers in financial markets and asked them for a run-down on what exactly happened. Here are their joint answers to the questions we put to them.
- What is short selling and how does it work?
Short selling is a bit like the revenge of the little guy against the big guy. What the small guys are doing is saying “we know there are some short sellers out there they’ve got big positions and if we buy all the stock the short sellers are going lose money because the price is going to go up” and it’s the power of everyone acting together to buy these unloved stocks, like GameStop, which is a traditional bricks and mortar video and gaming store. However, it’s not just GameStop. There’s been other companies like Nokia, Blackberry, AMC, and a lot of so called ‘unfashionable’ companies.
There’s the element that this is the little guy who’s very frustrated about the unequal power in the market because of the big hedge funds and the big people in the know on Wall Street. You could say the same about the Australian market, ganging up and saying this is a chance for a bit of fun and revenge.
- What is short selling?
When you buy a stock, you hope the price is going to go up, so you pay $10 for a share to sell it back at $15 and you make $5. Short selling is the opposite: you sell it at $10 because you want to buy it back at $5 and make $5 by buying it cheaper. You’ve got to borrow the share from another party and at some stage, give them the share back.
- When the stock is leant out, is the ownership still in the name of the superfund or does it go to the short seller?
The ownership transfers to the short seller. What the short seller does is they go to sell the shares on market, come along to the friendly superfund and say, “look I need to borrow these shares.” If I were the short seller in this scenario and you’re the superfund, I pay you some cash as collateral, so you’re covered from a security point of view. I make the delivery into the market and the shares go out of your name into my name and effectively into the persons who ends up buying them. At the same time, I have a contract with you to give you those back and that’s how you’re covered, so at some stage I’m going to go back into the market, buy my shares and deliver them, back to you.
- The fact that I’m selling these shares doesn’t necessarily mean the price will falls much as short sellers wants it to, right?
No, sometimes short selling doesn’t work at all. I have an obligation to return the shares back to you at exactly the same price, but sometimes the short seller can’t buy back the shares at a price below what he/she sold them for, and they lose money. Then they’re going to be forced to cover their position and potentially the higher the price goes up the more pain they start to feel and the more likely they are to cover their short.
It’s just about selling something at a higher price, buying back at a lower price and to do that you just have to borrow the stock and when you buy it back you return the stock.
- What have the Reddit investors done?
The Reddit investors have worked out there’s a lot of short positions already in a company like GameStop because the short sellers typically have to publish their positions or tell the market. In Australia there’s a report every day that tells all the short positions and all the major companies. What they’ve done is worked out “hang on, there was a big short position in GameStop. If we all together suddenly bought shares, we’d move the price up and we’d make it more painful, and if enough of us joined in we could make the price go higher and higher.”
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
