Key Points
- Short squeeze & momentum trading pushing GameStop higher.
- We took profits in retail ETF with exposure to GameStop.
- Allocated proceeds to existing sector allocations
This past week has generated some exciting headlines in the financial media. GameStop, a video game retailer, appears to be the subject of a short squeeze, causing the stock price to skyrocket over 1000% since the start of the year.
A short squeeze occurs when an investor takes a short position in a stock, in other words, they are betting the stock price goes down. If the stock price instead goes up, the investor that took a short position must purchase the shares back at a higher price and will incur a loss (they are “squeezed out” of the position). Short selling is risky as the potential loss an investor could face is limitless.
In situations like GameStop, a variety of factors likely converged to drive the price higher. The first is that the short sellers must buy higher-priced shares to cover their position. Call options, which allow an investor to buy a stock at a predefined price, may have also played a role. The call option issuer may need to hedge their exposure by purchasing the underlying stock, which can push the price higher. While it is still early to determine the primary factor, it appears that a populist movement by retail traders played a significant role. In the days ahead, we will continue to learn more about the forces that came together to cause this dislocation, as well as how regulators will respond.
It is important to remember that market dislocations like this have occurred numerous times throughout history. The Dutch tulip mania in the 1630s is considered the oldest. The most recent (prior to GameStop) was just last year when oil prices went negative, costing traders millions of dollars. The lesson in this is that these types of events happen in the markets. Going forward, the market will adjust, market participants will be savvier, and regulators will impose restrictions to deter against the same activity in the future.
Within our PFG Strategies, we had some exposure to GameStop through a Retail ETF position. On Monday, January 25th, after seeing that GameStop was becoming a much larger portion of that holding, and given the meteoric rise in the price was purely based on a short squeeze, we elected to exit the position and realized a significant gain. Proceeds from the sale were deployed across other cyclical sectors themes in our strategies.
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