Game Over For Gamestop?

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by Dave Kranzler of Investment Research Dynamics

“If you can’t spot the sucker in the first half hour at the poker table, then you are the sucker.” – a quote attributable to several sources.

Well, easy come, easy go for the Reddit retail traders who rode their GME shares and call options up and then back down. Since hitting $483 last Thursday, GME has lost over $29 billion in market cap. That money didn’t just disappear. It was transferred from those sold out their shares while GME was trading at much higher levels. More than likely, most of the entities that reaped big profits were sophisticated traders and hedge funds. The biggest losers were the new retail traders spawned in March/ April 2020 that opened up accounts at zero-commission trading apps like Robinhood.

As a matter of fact, the Wall Street Journal featured an article about Senvest, a hedge fund that started buying GME in September and sold their shares when the stock went above $400, netting nearly $700 million. However, around the time Senvest began accumulating GME shares is about the time the original “short burn of the century” appeared on Reddit. There’s speculation that Senvest was behind that Reddit post. The post contained an explanation of how a short-squeeze is orchestrated. That’s the type of information harbored by sophisticated Wall Street trading veterans – not zero-commission-based retail odd-lot traders.

A bona fide short-squeeze occurs when a group of entities, with a decent-sized long position that has been lent out to short-sellers in a high short-interest stock collectively at the same time, issues a recall on the shares that were lent out to be shorted. The share borrower has three days to return the shares, which means if it can’t secure more shares to borrow, it has to buy shares in the market and return them to the lender. If the recalled short is not returned in three days, the entity that lent the shares has the right to “buy-in” the shares in the market at any price. The borrower is required to pay the amount that it cost to for the lender to repurchase the shares.

An orchestrated short-squeeze causes the chart formation seen in stocks like GME that have been squeezed. In this case the Reddit Wallstreetbets chat room added gasoline the short-squeeze fire by seducing an “army” of retail buyers to chase the shares higher with share purchases and OTM call purchases. The massive volume of OTM calls purchased also created a “gamma squeeze,” as options market makers shorting the calls also buy shares to “delta hedge” the calls they were shorting.

The short-squeeze is pretty much over now. It’s estimated that the short interest in GME is now well below 100%. Volume in GME shares on three of the five days this past week was well below 10-day average volume. The implied volatility of the options has declined by more than  50%, depending on the strike and expiration. The big upside “wick” on Friday’s green candle in the chart above was formed by a big jump in GME’s price at Friday’s open which was triggered when Robinhood and a few other retail trading platforms removed trading restrictions on stocks like GME and AMC. That alone tells us the short-squeeze has subsided.

At this point GME will likely experience high two-way volatility but ultimately will head lower from here. There’s many retail bag-holders who bought shares and calls at much higher prices. Once again Wall Street and sophisticated hedge funds have taken advantage of retail suckers who, since last Friday, have been “waiting for the stock to bounce back close to my cost” before selling. Good luck with that.

Gamestop’s plight is similar to that of Blockbuster. Its business model is a dinosaur, largely predicated on selling gaming hardware and games via brick/mortar store outlets.  The Company been left in the dust by online streaming gaming venues and online retailers of gaming hardware. Competition in the sector is brutal. GME did not try to take advantage of the high stock price to issue $100’s of millions worth of shares because it inevitably would have faced an onslaught of shareholder lawsuits and it’s likely the SEC would not have approved the deal after the Hertz debacle.

There is a reason GME had such a huge short-interest before this short-squeeze episode. Over its last two fiscal years it lost a combined $1.1 billion.  Its revenues plunged from $8.2 billion in its FY 2019 to $5.1 billion – 37.8%- on a trailing twelve month basis. The Company is headed for the graveyard.  I don’t know if CHWY’s Ryan Cohen will make a bona fide effort to move GME completely online.  Hell, Cohen can’t turn CHWY into a profitable business. But I don’t think it will matter if he proceeds to migrate GME to the digital world. GME in my view is a zombie following the retail investors off a cliff.  Good luck if you own GME shares, especially at much higher levels.

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