'GameStop effect' could ripple further as Wall Street eyes short squeeze candidates

The clash between retail traders and Wall Street professionals that sparked roller coaster rides in the shares of GameStop Corp may pose a risk to dozens of other stocks and potentially create a headache for the broader market, analysts said.

A GameStop store in Alhambra, California. Photo: AFP

Market watchers identified dozens of stocks potentially vulnerable to extreme volatility after a buying spree from an army of retail traders in recent days prompted hedge funds to unwind their bets against GameStop and other companies, fuelling surges in their share prices in a phenomenon known as a “short squeeze.”

“Unfortunately, it’s definitely not a one-off thing,” said Randy Frederick, vice president of trading and derivatives at the Schwab Centre for Financial Research. “The type of activity that drove that higher, I believe, has caused people to try to duplicate that in other names.”

J P Morgan earlier this week named 45 stocks that may be susceptible to short squeezes and similar “fragility events,” including real estate company Macerich, restaurant chain Cheesecake Factory and clothing subscription service Stitch Fix.

Like GameStop, American Airlines Group, AMC Entertainment Holdings and others that have become targets of retail traders in recent days, all the stocks have high short interest ratios.

American Airlines Group, AMC Entertainment Holdings and others have become targets of retail traders in recent days. (file pic) Photo: 123RF

Warning of ‘dangerous precedent’

That means a large percentage of investors have borrowed the stock to sell it in anticipation that they will be able to buy it back at a lower price and profit on the trade. But if the stock rises sharply, those investors may be forced to buy back the stock at a loss.

“The unfortunate events in GameStop this week may be building a dangerous precedent for markets whereby retail investors act en masse to leverage their buying powers to spark fragility events,” analysts at JP Morgan said in a note.

Using derivatives and coordinating buying on websites such as the Reddit forum wallstreetbets, retail investors have had an outsize impact on markets in recent months. Hedge funds Melvin Capital Management and Citron Capital closed out short positions in GameStop earlier this week after buying pressure pushed up the company’s shares.

GameStop shares were recently down 25 percent on Thursday (US time) as retail brokerages Robinhood Markets and Interactive Brokers restricted purchases of the stock, along with several others that have catapulted in recent days, including AMC Entertainment Group and BlackBerry. Even so, the video game retailer’s shares have gained more than 500 percent since last Thursday.

Barring wider trading restrictions, similar patterns could play out over several weeks as short sellers unwind their bets, chief executive of Tallbacken Capital Advisors Michael Purves said.

Some firms run strategies that involve holding both long and short positions on a stock, he said, and as a result, certain stocks could see a surge and then a sharp drop as those firms adjust their positions. That process could put pressure on stocks more broadly and contribute to market volatility.

“I do think the contagion risk is real,” Purves said. “Any stock that is heavily shorted is exposed to getting GameStopped.”

– Reuters