Major retailers run loss leader sales simultaneously on toilet paper. Consumers buy to stock up at a bargain price. A week later, these companies find their reorders are cut or refused. It turns out, manufacturers oversold toilet paper by 140%. Word gets out of a severe shortage, and People bid up the existing supply and hoard it. The price of toilet paper soars. The manufacturers face very costly lawsuits for failure to deliver. This scenario sounds familiar. That’s because we just had a toilet paper shortage with sharply rising prices during our present pandemic.
Keeping this in mind will help us understand what happened with GameStop and other traded stocks. Some individual investors felt these beaten-down stocks were selling below their actual worth. They bought and shared their reasons for buying with others on the internet. They may or may not have been aware of large short positions, but it would become apparent in any case as the share prices jumped.
Short selling is a widely used method of selling something today for delivery or liquidation later. Futures markets exist for most of the things we need. A farmer looking at the corn vs. soybeans price for delivery next November chooses the more profitable to plant. The farmer then sells corn contracts for delivery at that time. The farmer presently has no corn but will have by fall. By what we call hedging, the farmer locks in his profit. People needing corn in the future are on the buy-side. We do this with everything from copper to U.S. Treasury Bonds. We’ve done this for a long time. The Chicago Board of Trade dates back to 1848.
Other people see the November price of corn as too high or too low, and they buy and sell contracts simply hoping to profit from the price movements. These traders have no corn now or use for it in the future. These speculators are welcome to give liquidity to these markets.
Selling something you don’t own is nothing new and is needed to facilitate commerce. However, stock trading has an added wrinkle. Because of settlement rules, short-sellers have to borrow the stock to settle the trade. Generally, brokers facilitate this between their clients, but not having enough supply to borrow is always dangerous for the short seller.Continue reading