GameStop Mania, Echoes from Martin Shkreli’s KaloBios Infinity Squeeze
The GameStop mania background
On January 27, 2021, Melvin Capital announced that it was covering its short position on GameStop Corporation (NYSE: GME). Other hedge funds, such as Citron Capital, followed soon after as the GME stock continued to soar for the skies. Celebrity short-seller Andrew Left of Citron Capital said on the same day that GME’s price growth caused his firm losses of up to 100%.
What happened? GameStop Corporation is a video game retailer that sells its wares the old-fashioned way, through physical stores. The 37-year-old company's business has been declining lately, largely due to an outdated business model. Investors on the NYSE had noted GME’s situation and had sold the stock to about $3.30 in August 2019.
Another group of players who took notice of GME’s slow death was short sellers. In mid-August 2020, Melvin Capital, a hedge fund, filed Form 13F, and it revealed a massive short position against GME. Some keen Reddit users noticed the position and started pumping it via the WallStreetBets (WSB) subreddit. Their thesis? Buy up as much GME stock as possible to squeeze out shorts.
The KaloBios short crashed a retail trader
Hedge funds have monopolized the short selling market, but retail traders have not been left out. And the retail investors have also faced dire situations the same way as Melvin Capital. In mid-November 2015, a GoFundMe page hit the news asking for assistance to cover a $106,445.56 debt. According to the details supplied, Joe Campbell was the person asking for help.
What happened? The story behind Joe Campbell’s decline into debilitating debt mirrors Melvin Capital’s. As per his analysis, Campbell was certain that KaloBios (NASDAQ: KBIO) was on the verge of collapse following a series of mishaps. As any short-seller would do, Campbell shorted KBIO using an E-Trade trading account, which had $37,000 when he went to sleep.
While Campbell counted on profits soon, an investor by the name Martin Shkreli had swooped into KBIO’s rescue. After the KBIO price touched its nadir at 44 cents on November 16, 2015, Shkreli snapped up 50% of the company's shares. This activity pushed KBIO's price significantly up to $2 two days later and more than $14 a few hours later.
Squeezing shorts to infinity
The two stories we have seen far are interesting as they are educating. Both of them are classic studies in short-selling and short squeezes. Plenty of similarities and differences are present in the two cases. However, you might want a refresher on short-selling and short squeezes before we proceed with the discussion.
Short-selling is a trading technique much like long trading in principle. Long traders buy a stock at low prices and sell it after some growth and take the difference as profit. In this case, the fundamental principle is the belief that the stock’s price will eventually rise above what you acquired it for.
Short sellers' primary principle is that the future price will not be the same as today. They pick shares of companies whose future looks bleak and whose price can only go down as per their assessment. Therefore, a short seller borrows some shares from the broker and sells them, intending to buy them back at an even lower price. The trick here is to sell high and buy low, and the difference amounts to profits.
For long traders, their position becomes lossmaking when the stock declines in the future. As for short-sellers, their positions in stock turn sour when the share price growth suddenly turns positive. Since the short sellers must return the borrowed shares, they might have to buy higher than intended to cover their losses. The urgency to buy increases as the price grows, which leads to more shorts being squeezed out of their positions, hence a short squeeze.
Similarities between the GameStop and KaloBios scenarios
The GameStop mania mirrors the KaloBios short squeeze in all its technical forms. In KBIO's case, shorts ran for the door when Shkreli started pumping the stock, leading to even wilder price movements. At the end of the rally, traders such as Campbell were deep in the negative. The same happened to Melvin Capital. Before the GameStop squeeze could even reach the climax, Melvin Capital exited the short position, having burned more than half of its capital.
Another similarity in the two cases is that the shorts thought of the target stocks as easy to short. For GameStop, all indications pointed to the retailer going out of business sooner or later. In 2020, GME shares averaged around $7, and the lowest price was at $2.57 when the Covid-19 pandemic started to bite economically.
KaloBios was equally in dire straits. The pharmaceutical company did not have a viable drug candidate in the pipeline, and it was deep in unpayable debt. However, the shorts failed to seriously consider the parties on the opposite side of their positions. A group of Redditors quickly turned GME around, so did Shkreli for KBIO.
There are differences too …
Before Martin Shkreli descended upon KaloBios with his millions, the company was almost breathing its last. The company had explored deals with Geron (NASDAQ: GERN), but they had fallen through. Rumors were rife that the company was exploring liquidation of assets. As such, one can argue that Shkreli merely saw an opportunity to pump and dump KBIO.
On the contrary, the GameStop story is an interesting one. It is a story that will go down as Wall Street’s darkest days as retail traders gave hedge funds a taste of their own medicine, which Bloomberg called an “epic short squeeze.” Bloomberg further argued that the “The Battler of GameStop” was a rage against Wall Street practices.
Unlike KaloBios where Shkreli simply bought shares and put out press releases, the Redditors who bought GameStop talked up the stock on social media all day. The Redditors did not even buy the GME shares directly; instead, they bought options. This way, they could leverage their positions and squeeze Citron, Melvin, and others so tight and fast.