GameStop and the gamification of retail speculation

| By Assistant Professor Ben Charoenwong |

US-listed GameStop has hit the financial news headlines as being the centre of a tug of war between big-money hedge funds short-selling the shares (or betting that it will fall); and small-time retail traders on Reddit’s WallStreetBets (/r/WSB) going the other way and betting that the shares will rise. Filmmakers from MGM to HBO and Netflix are lining up to make movies about this purported David-versus-Goliath struggle.

Following the meteoric rise in GameStop share prices, the “degenerates” on /r/WSB had celebrated their revolution by imposing losses on hedge funds betting against the stock. But unfortunately, the upwards price movements caused by retail and swing traders (that likely included other hedge funds) may send another message: you can get rich quick.

There are some on /r/WSB with fairly sophisticated knowledge of financial markets, analyzing short sale interests and intra-day price movements, and performing scenario analyses to assess hedge funds positions. These posts are labeled “DD”, for due diligence.

Some read the analyses. Some others do not even understand the analyses but become convinced that there is some method behind the madness, following the recommendations anyways.

Fintech: Brokering Lottery Tickets

Retail speculation has been around for hundreds of years, but never before have they been given credit for affecting such dramatic stock price movements so quickly. What makes this time different?

Short answer: financial technology. The proliferation of gamified, simple, and cheap access to trading has enabled retail investors to cheaply express their speculative views, whether or not there is any research or informed opinion backing the trade. In fact, the congressional hearing recently, which included the Robinhood CEO, Reddit CEO, and a /r/WSB trader was exactly on the gamification of stock investing and the role of social media. Moreover, retailers’ access to derivative financial instruments has increased the price impact on the market through the implicit leverage.

In particular, the intense vertical rocket-like movement has been attributed by some financial analysts to retail call option purchases. Call options are securities that give you the right, but not the obligation, to buy the underlying stock (GameStop in this case) at a specific strike price by a specific point of time.

For example, buying an option on 12 Jan with an expiry date on 19 Feb for the right to buy GameStop 100 shares for US$20 cost a premium of around $315. If GameStop shares hit US$50 on 19 Feb, then the investor gains US$3,000. Getting the same gain by buying shares directly would have required an initial up-front investment of US$2,000, for a gain of 150 per cent, whereas the option position had a gain of over 850 per cent. The implicit leverage in options allows retail investors to obtain the same payout with much lower initial investments, effectively allowing them to trade a larger notional than they could with directly buying shares.

That people may buy long-shot bets is nothing new – academic research has documented the tendency of retail investors to overpay relative to fundamental value for stocks whose return profile exhibits lottery-like characteristics. With more sophisticated financial instruments available, combined with the /r/WSB message board and the gamification of trading by fintech brokers like Robinhood, retail investors could not only express their speculative views, but do so with increased firepower.

More fun than a casino

Even if we know the returns are not sustainable, speculating in financial markets can still be more fun than going to the casino. With stock markets, at least you don’t really know the probability of winning or losing, whereas in a casino, many games are based on a set of rules and participants know that there is a house edge. Risk-loving casino visitors are willing to pay that edge in order to take on some risk, for the “lulz”.

That popular icons publicly support the “movement” likely also increased participation. But stay in the markets long enough and one develops a healthy dose of skepticism. Seeing the likes of Elon Musk, Mark Cuban, or Chamath Palihapitiya supporting the /r/WSB movement publicly also seems more a press stunt rather than a genuinely principled stand. For all three, public support generates a contrarian view that generates press. Even if they are personally invested, they are likely not betting anything close to a substantial fraction of their wealth.

We should also consider whether the party has ended by the time we hear about it. Suppose you buy S$20,000 worth of GameStop shares on 1 Feb after reading the Straits Times article that said an NUS undergraduate student turned S$20,000 to over S$100,000 in (unrealized gains) trading GameStop.

In a mere week, you would have S$5,310 as of Friday, 5 Feb, a whopping 76 per cent loss of S$14,690. The only thing worse than losing almost S$15,000 in a week is knowing if you just entered the trade one week before and also held for the same one week, it would have been worth over $30,000.

But perhaps we all dislike Wall Street so much that the GameStop rocket falling back to earth with an 80 per cent loss in three days was worth sending a message.

One question is whether such a coordinated short squeeze will repeat randomly as /r/WSB targets stocks based on a combination of nostalgia, short interest data, and sheer virality against some unfortunate hedge fund who finds itself in crosshairs. But in the gambler’s fever dream-cum-Occupy Wall Street-cum-get rich quick scheme, it seems only the last part will remain.

Fast forward a couple of weeks, an eternity in such a volatile instrument, the “get rich quick” message appears to be the only lasting impression. Redditors appear to have shifted interest to Dogecoin, sending the value from approximately half a cent to over 7 cents per coin, a return of 14 times. But unfortunately, there isn’t any revolution to be had there.


About the author

Assistant Professor Ben Charoenwong is from the Department of Finance at NUS Business School. His research focuses on household investment behavior and the regulation of financial advisers. He is also co-founder and Head of Research at Chicago Global, a quantitative global investment fund.