Lesson A6.3 · 3 of 5 · Special situations
Short squeeze explained: what the GameStop case of 2021 showed
A short squeeze happens when a heavily shorted share rises fast and short sellers are forced to buy back, pushing the price higher still. With GameStop, the SEC staff report of 2021 found that the rally was sustained mainly by optimistic buyers, not by short sellers covering.
Terms in this lesson
- Short selling
- You sell borrowed shares, hoping to buy them back cheaper.
- Short interest
- What share of the freely traded stock has been sold short.
- Margin call
- The broker asks you to add money, because losses have eaten into your collateral.
How a short squeeze works
How shares are borrowed and sold, why the loss is unlimited and how margin works are covered in the Trading School lesson on short selling. Here we look at what happens when many short sellers crowd into the same share and the price starts to climb.
Definition
The chain of a short squeeze
Large short positions, heavy buying, margin calls, forced covering, an even higher price.
A squeeze does not need good news about the company. It is enough for short sellers to be numerous relative to the shares available and for the price to rise fast enough to force them out.
- Large short positionsMany shares borrowed and sold, relative to those available.
- Heavy buyingNews, excitement or a social media campaign lifts the price.
- Margin callsBrokers demand more cash or close short positions at a loss.
- Forced coveringShort sellers buy shares to return them.
Two figures show how crowded a share is: short interest as a percentage of the free float (the shares available to trade), and days to cover, which is short interest divided by average daily volume. The higher they are, the harder it is for short sellers to get out.
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Create a free accountGameStop in January 2021: short interest and the timeline
Short interest in January 2021, as a percentage “of float” as the SEC staff report presents it (calculated against shares outstanding): GameStop 122.97%, Dillard’s 77.3%, Bed Bath & Beyond 66.02%, National Beverage 62.59%, AMC 11.4%, Naked Brand 7.3%, Koss 0.92%.
According to the SEC staff report, short interest in GameStop (GME) hovered around 100% until early 2021 and reached 122.97% “of float” in January 2021, as the report puts it. A footnote explains that the ratio was calculated against shares outstanding, using CRSP data. Short interest can exceed 100% because a borrowed share that has been sold can be lent out again by whoever bought it. The price chart for those days is in the Beginner lesson on FOMO; prices are before GameStop’s share split of July 2022.
| Date | What happened |
|---|---|
| 25 January 2021 | Melvin Capital, a fund short GME, announces a $2.75bn investment from Citadel and Point72. |
| 27 January 2021 | GME closes at a high of $347.51, more than 17 times its close on 11 January. The clearing house NSCC makes intraday margin calls of $6.9bn on 36 members. |
| 28 January 2021 | GME hits $483.00 intraday and closes at $193.60. A broker restricts new purchases in eight stocks, including GME. |
| 14 October 2021 | The SEC publishes its staff report on market conditions in early 2021. |
| 18 May 2022 | Melvin Capital announces it will wind down its funds. |
Based on the SEC staff report (14 October 2021), Melvin’s press release of 25 January 2021 and Fortune (19 May 2022).
What the SEC staff report of October 2021 found
SEC, 14 October 2021
What drove the GameStop price up?
SEC staff concluded that positive sentiment, not buying to cover, sustained the weeks-long rise.
The report shows that buying by short sellers covering their positions was a small fraction of overall buy volume, and that the price stayed high after the direct effect of covering would have faded. Covering probably did add to some price rises at particular times. On the “gamma squeeze” (a rise driven by market makers buying shares to hedge call options they have sold), SEC staff say they found no evidence of one in GME in January 2021; the jump in options volume was driven mostly by buying of puts rather than calls.
On the restrictions of 28 January, the report shows that some brokers limited trading in response to margin calls and capital charges from NSCC, the clearing house that guarantees settlement. When volatility rises, the collateral demanded from brokers rises too.
Melvin Capital and the lesson for investors
Melvin Capital began 2021 with about $12.5bn and ended January with more than $8bn in assets, after closing its GameStop short at a large loss. According to Bloomberg, cited by Fortune, the fund finished 2021 down 39%. On the other side, anyone who bought GME at the record close was down more than 80% nine days later, as the FOMO lesson shows.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: SEC, “Staff Report on Equity and Options Market Structure Conditions in Early 2021”, 14 October 2021 (short interest, GME prices, covering, gamma squeeze, options, NSCC, broker restrictions); Melvin Capital press release of 25 January 2021 (PR Newswire); Reuters, 31 January 2021 (Business Standard); Fortune, 19 May 2022; our own calculations.