Should We Fight Short-Sellers?

Harold Lutz: Who the hell are you?

Axel Foley: Uh, my name is Johnny Wish-Wishbone. Johnny Wishbone. And I am a psychic from the island of St. Croix. Yes, I am psychic from the island of St. Croix. And I read in the St. Croix Gazette that the Beverly Hills Police Department having some trouble figuring out crimes. So, what I did was come to Beverly Hills to help the police out. They tell me they don’t want my help, they don’t *need* my help, so I’m gonna go on my merry way. I’m a psychic! I am a psychic phenomenon. Watch this. I don’t know who you are, but watch this. Ummm… Your name is, ummmm, Lutz! Right? Chief Lutz. That’s your name. See? The name pop inside my head like that. And your name is, ummmmm, ummmmm…

Biddle: Biddle?

Axel Foley: Biddle! Yes, see? I- You- Two more seconds I would have said it myself. I don’t need no help from no one, because I’m Johnny Wishbone, psychic extraordinaire. And if you need me, just think “Johnny Wishbone” and I come running. Lutz and Biddle, it’s like Kibbles n’ Bits, but different.

I happened to catch the last hour of “Beverly Hills Cop 2” (BHC2) yesterday, and the suspension of disbelief that the movie requires reminds me of how people who are buying meme stocks also have to suspend their disbelief.

Suspension of disbelief means ignoring the silliness and even the implausibility of what’s happening in a movie or a stock. When you see Axel Foley pull a nail file out of his pocket and easily pick a lock to get into a Beverly Hills mansion, or when you see him and his pals shoot hundreds of rounds of bullets into a crowd without hitting any bystanders, you’re suspending your disbelief.

Similarly, when you see someone on Twitter post a picture of a man playing video games that causes a struggling video game retailer’s (GameStop (GME)) stock to go up 300% in the premarket, it feels like you’re watching BHC2 because you can hardly believe it’s happening in real life.

I enjoyed BHC2 the first time I watched it in the movie theater as a high school student thirty years ago, and I still enjoyed some of the humor when I watched it the other day. Likewise, I somewhat enjoyed watching GameStop’s stock go wild because someone on Reddit posted a screenshot of an account holding millions of dollars in GME stock and call options. But I wouldn’t want to play the GME trading game. Whoever posted on Reddit might or might not be the same Roaring Kitty who helped cause the Mother Of All Short Squeezes (MOASS) in GME in 2021 by rallying retail investors to plow their money into GameStop and force hedge funds to buy GME stock to cover their naked short positions. The poster might not even own those millions of dollars of GME stock and options. But many retail investors immediately suspended their disbelief and plowed millions into GME.

The biggest problem for those trying to create a new MOASS in GME now, compared to 2021, is that hedge funds are no longer nakedly short GME. In 2021, the short interest in GME was over 100%, meaning many hedge funds had (probably illegally) sold GME shares without actually borrowing them first, which is required when short-selling a stock.

Let’s back up for a moment and explain what short-selling and naked short-selling are.

Imagine you go to a party on a Friday night, and the hosts run out of beer. You know your ex-girlfriend, with whom you’re still cool, has a couple of cases of Coors in her basement, so you run over to her house and ask if you can borrow those cases for a couple of days. You take them back to the party and sell each can of beer for $10. You’re now “short” two cases of beer because you borrowed and then sold the beer, but you got permission from your ex, so everything’s cool. On Monday morning, you buy two cases of Coors at $1 a beer, replace the beer you borrowed, and make 90% on the trade—a kosher short sell.

On the other hand, a person with lesser ethics might have “borrowed”/stolen the beer without telling their ex and then went and sold it at the party for $10 a beer. When the ex-girlfriend sees her beer is gone, she calls the cops, who arrest you. By the time you get out of jail, there’s been a beer shortage, and a case of Coors now costs $100 a beer. You have no choice but to buy that beer to replace what you “borrowed”/stole. You just lost 1000% on that trade—an illegal naked short sell.

So back in 2021, when Roaring Kitty helped build an army of retail investors that created the MOASS on GME, there were naked shorts who had sold GME shares without borrowing them first. Every GME short seller, like our beer short seller, has to buy back those shares at some point and return them to their rightful owners (unless the stock goes to zero). When 150% of the total shares outstanding were sold short, it meant retail investors (by buying GME stock en masse) could force those short sellers to buy back GME at higher levels as they got margin calls from their brokers, as in the $100-a-beer example. This time, however, only 20% of all outstanding GME shares are sold short, meaning those short sellers can probably cover their shares more easily and won’t be squeezed as hard as in 2021. In other words, it would take significantly more money from retail investor buying GME to force the same kind of squeeze we saw three years ago, and that probably isn’t going to happen again.

Meanwhile, GameStop is still a struggling video game retailer with little growth prospects and questionable survival potential over the next five years. If you’re in the business of building wealth slowly but surely and as safely as possible, you probably want to avoid this entire Beverly Hills Cop 2/GameStop movie.

Let’s stick with revolutionary companies like Tesla (TSLA), Meta (META), or Tencent (TCEHY) in China, which are changing the world.