The Melvin Capital fund received a loan of USD 2.75 billion to cover losses. GameStop stock is up 1,778% since the beginning of the year, thanks to Redditors.
After it was about to fall for bankruptcy, the recovery of the video game store GameStop started a confrontation between big Wall Street finance companies and a group of retail investors to the news table.
As a result of the Covid pandemic, GameStop entered a downward spiral in March 2020. GameStop’s share went from USD 18.40 at the start of 2020, and by July of that year, it had dropped to USD 4.50.
Despite a gradual rally in the share price, that ended the year at $ 17, many large Wall Street investors decided to short GameStop. In other words, they bet that the price would go down at the end of January.
Short positions are common on Wall Street. If an investor believes that an individual share will fall in price, he borrows shares from an investment bank for a specified amount of time and sells them at the current market price.
If the share does fall in price, the investor buys the cheapest shares, returns them to the investment bank, and pays the respective commissions. The short investor’s profit depends on how much the share price has fallen.
The risk of this type of operation is that the share price rises because he must return the shares to the borrowing bank and bear the losses at the end of the stipulated period. In GameStop’s case, the price went up on a large scale.
Huge Bets with GameStop Represent a Proportional Risk
GameStop shares that went on a short trade were not a small bet; the amount was about $ 72 million. If we take on a one-time hypothetical loan of 72 million shares with a contract taken on January 1, when the percentage was worth $ 17.25, the downside bet amount would be $ 1,242 million. And if the price just decreased, the profit would have been $ 720 million, $ 10 per share.
As more retail investors joined the WallStreetBets call for different reasons and GameStop’s price rose, large investors’ losses widened. On January 14, GameStop’s price touched $ 40 and brought total losses to more than $ 2 billion. And these losses, this Monday, January 25, with the share at USD 77, exceeded USD 4.2 billion.
Melvin Capital, a mutual fund manager with $ 12.5 billion in assets, is one of the hardest hit. After the price started to rise, the firm placed even more capital into the short positions as it believed the price would eventually fall. But that move just failed.
Melvin Capital liquidated its short positions for USD 147. The losses are not exact, but the amount is circling the billions of dollars. Hedge funds Citadel and Point72 made a loan to Melvin Capital close to $ 3 billion to meet these losses. GameStop’s share price was USD 324, representing a 1.774% appreciation compared to January 1, 2021.
By: Jenson Nuñez
