What Hedge Funds Actually Did to Deserve Investor Revenge

Jordan

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For most people in the world right now, the drama that’s unfolding on the stock market looks completely insane and unjustified.

It can feel strange to hear from every corner of the internet that the hedge funds “deserve this” and that all these big money guys are evil.

What could anyone have done to deserve this much of an outcry from the Reddit community?

In case you haven’t heard, the subreddit WallStreetBets banded together and bought up the shares of failing retailer GameStop over December and January.
This collective action caused the $18 share price to skyrocket to over $300 at close of market last week. We’ve since seen the market dip back down today, and there may be some shady reasons why that’s happened that we’ll get to later.

But first, why would Reddit band together to force up the price of a share? They did it because of the short positions.

The Big Shorts

Melvin Capital and other hedge funds took massive short positions out on GameStop, and if you don’t know what that means, please read my previous article where I go into more detail about what a short position actually is.

All caught up? Now let's get into why these hedge fund managers deserved to lose everything.

During the first half of 2020, GameStop stock fell to $4 per share. It was a retailer like many others; desperate, haemorrhaging cash, and running out of options.

It was during these months that Melvin Capital and its friends bought up their short positions, which itself isn’t necessarily an evil thing to do. It’s a legitimate investment option for very rich people, and can be a good way to capitalise on a situation that’s guaranteed to go bad.

However, what Melvin and the boys didn’t see coming was GameStop’s upcoming change of fate. In August 2020, Ryan Cohen started buying up GameStop shares. (Cohen is the CEO of e-commerce company Chewy, a company that was bought up by PetSmart for $3.35 billion).
Cohen and his company RC Ventures continued buying shares until by December, he owned 13% of GameStop, roughly 9 million shares.

Soon after, Cohen and two other former Chewy executives were appointed to GameStop’s board. They were young, wealthy, and they had the e-commerce experience that GameStop desperately needed.

Part of the reason GameStop fell so close to bankruptcy in the first place is because of how far they’d fallen behind console manufacturers such as Sony and Microsoft in being able to capitalise on online retail.
GameStop still serves a purpose by selling consoles in-store and trading used games, but without a cutting edge online presence, they couldn’t make the money needed to stay competitive.

By joining GameStop, the new board members brought with them the experience needed to formulate a plan to bring the company back to profitability and success, but this plan flew right in the face of Melvin and the other hedge funds.

With every dollar that Cohen added to GameStop’s share price, Melvin lost money in its short position.

Desperate, Melvin had to come up with a plan to keep the stock price down. In an attempt to shake investor confidence, the hedge fund started buying up more short positions on the day that Cohen and the other Chewy executives were brought onto the board. It was this move that enraged Redditors all over the world.

8 months ago, GameStop was in a horrible position because they failed to innovate and weren’t making enough money to cover costs. This is the savage business of retail, and is hardly something new.
However, GameStop actually had a plan and a new board who were willing to give it another try and had a plan to fix the business.
But in a synical attempt to avoid losing any money, Melvin Capital actively conspired to force the share price back down and push GameStop closer to bankruptcy. It’s as though GameStop is holding onto a cliff and Melvin Capital is desperately stomping on its fingers, knowing that a big payday will come the second it dies.

Melvin kept buying shorts, and eventually bought up 71 million, even though GameStop has under 70 million shares in total. Big red flag.

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Shady Territory

If you have a look at all the GameStop shares and take away the ones owned by executives and venture capital firms, there are only between 20 and 30 million shares available on the free market.

This means that 70 million shorts need to be covered, but only half of them actually can be. This enormous demand and very limited supply is what started pushing the price of the share up.

This is where WallStreetBets comes in. They saw the horrible position that the hedge funds had forced themselves into, and knew that by buying up all the shares they could and holding them, it would create a ‘short squeeze.’ The funds would try desperately to buy any shares they could find, and the more they tried, the higher the price would soar as supply couldn’t hope to match demand.

The longer a fund holds onto its short positions, the more interest it needs to pay. Melvin Capital has already been bailed-out by Citadel, and there’s talk that another bigger bail-out coming their way in the near future.

So why did the share price fall so far today?

There are a lot of reasons why the share price could have taken such a huge hit today, but none of them guarantee that the price won’t bounce straight back tomorrow. These reasons range from the frustrating, to the unethical, to the illegal.

Firstly, a lot of trading platforms are restricting access to GameStop shares (and other companies in a similar position as well).

At first it was just Robinhood restricting access to retail investors, but now its banks and platforms all over the world. According to the platforms, they’re doing this in an attempt to protect capital and rebalance the market before the entire economy collapses.

However, from the perspective of retail investors, it’s a coordinated effort by the platforms to help the funds regain their capital. Many of these platforms, including Robinhood, are connected to and funded by these large hedge funds.

Another reason why the price could have fallen is what’s called a ‘short ladder attack.’
In very basic terms, this is when two or three very large players sell enormous amounts of shares to each other back and forth enough times until they simulate a free-flowing market and give the appearance that there are enough shares to meet demand.

The appearance of free-flowing shares, coupled with a lot few retail investors being able to buy any (thanks to the platforms blocking access) is enough to lower the price of the share.

One more method is what’s called ‘reset transactions’ and it’s an illegal way to cover your short position until the price of the share becomes more favourable.

To explain it in far far too simple terms, a reset transaction is exactly what it sounds like. The holder of the short enters into a transaction with the seller, coming to an amicable understanding under the table, thereby satisfying the debt on paper and reseting the dates, kicking the can further down the road to a time that might be more favourable.

For that to be possible, it would require all of big finance to be in this together, and would require the government to entirely look the other way while big money players manipulate the market.

Conclusion

The question I wrote this article to answer was, “what did the hedge funds do to deserve this kind of punishment?”
Well, once you’ve looked at the full timeline, the answer to that question is simple.

These hedge funds have manipulated the market to ensure that the companies they want to fail do indeed fail, and do so in a timely manner.
They want us investing in companies that they want us investing in, and they don’t want us looking too closely at how they do business.

This is the first time the curtain was pulled back during one of their takedown operations, and they didn’t like it.

The hedge funds deserve punishment because they see themselves as above the law and are actively working to ensure the wealth gap continues to widen.

Basically, the crash of 2008 taught them nothing more than that crime does in fact pay, handsomely.

It’s only been a couple of weeks, and we have seen a lot of shady practice in only a short time. Platforms are shutting retail investors out, media outlets misreporting information and calling out the retail investors and redditors as the bad guys, and all of us are truly seeing how much of the world these hedge funds truly control.

The answer is everything, they control everything. Because of this, buying and holding GameStop shares has become a way to stand up and say no to these giants. We can’t do much to defy them, but we have the power to hold our ground.

No matter how much they lie and bend the rules, they can’t change the law of math. They still have over 70 million shorts on only 20–30 million shares, and as long as we don’t sell, there’s nothing they can do about that.

Time will go on, and tricks will continue to be played. But eventually, if they can’t convince us to sell, no matter how big they are, they’re going to have to pay.

Sources: Globe News Wire, The Collective, ARS Technica, Reddit, Bloomberg

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