Meme stocks and Reddit’s Wall Street Bets have been behind some massive, short squeezes thus far in 2021. GameStop (GME) and AMC Entertainment (AMC) have been the most notable battleground stocks between hedge fund managers and retail traders. Hedge fund managers that have short positions on a stock profit when the stock declines. On the other hand, retail traders identify heavily shorted stocks and buy the stock with the intention to short squeeze these hedge funds and cause a dramatic rise in the stock price. Although this tug-a-war has worked for GME and AMC in the short term, deploying this tactic can be dangerous. These short squeezes result in astronomical stock appreciation, extreme valuation distortion, and liquidity issues, as trading can be halted when trading abnormalities are triggered. Here, I’ll break down the anatomy of a short position and the mechanics behind a short squeeze.
What’s A Short Position?
Short positions are taken by those who believe the company is overvalued and take the position that the stock will decline in value over the near term. Essentially, this is betting that the stock will decline and when the stock falls, the short position is profitable. Short positions are taken by borrowing shares and then selling the shares in the hope to subsequently buy back the shares at a lower price to capture the spread. For example, shares are borrowed and sold at $100, and over the near term, the shares fall to $75. Once these shares fall as expected, the short seller can then buy these shares back at $75 and return the borrowed shares while netting $25 per share in the process. Continue reading "Meme Stocks And Breaking Down Short Squeezes"
The theory
