Shares of AMC Entertainment (NYSE:AMC) plummeted 57% yesterday, a big setback to a week that had seen a short squeeze send the stock soaring over 800%. Similarly, GameStop (NYSE:GME) tumbled 44%, ending a multi-day rally that had allowed to quadruple in value.
But with a number of stock brokerages imposing limits on trading the stock — or preventing investors from buying the stock outright — it wasn’t a surprise to see them fall. Still, even though both stocks are off to the races again today, GameStop has momentum where AMC Entertainment does not, and there are several good reasons for this, mostly because AMC is no GameStop.
A virtuous circle
While there has always been tension between short-sellers and investors who are long holders of a stock, the recent battle of wills began when some investors on Reddit noticed hedge funds had placed enormous bets that GameStop’s stock price would fall.
They banded together and began buying out-of-the-money stock options, which caused the option sellers to buy shares of the underlying stock to reduce their risk, which had the effect of raising GameStop’s stock price. That encouraged more investors to buy more stock options, and the option sellers had to buy more GameStop stock, sending the retailer’s share price rocketing higher as the cycle continued.
Short-sellers are being bludgeoned by the price action, but there’s little they can do about it.
Short of time and money
To sell a stock short, investors actually borrow shares from a market maker who sells the shares on the market for them. Based on a belief the price will go lower, the investors will buy them back later and pocket the difference. It’s the same concept as a regular trade, only conducted in reverse.
In GameStop’s case, short-sellers had actually sold short well over 100% worth of the video game retailer’s float (that’s the amount of stock actually available for trading), which means there isn’t enough of the underlying stock available for them to cover their short position.
They can only sit and watch in horror as the stock price rises and their short position hemorrhages deeper losses. There’s been a suggestion that GameStop could issue more stock at vastly inflated prices, which would take the pressure off the short-sellers while lining its own pockets with potentially billions of dollars.
GameStop hasn’t indicated it intends to do anything like that, but that’s not something available to AMC Entertainment — and it’s one reason why the theater operator’s stock is tumbling while the video game retailer rises.
Pulling the plug
While there’s a dearth of GameStop stock, there’s plenty of AMC stock to go around. Make no mistake, as of Jan. 15, some 38% of the theater owner’s stock was sold short. That’s a significant amount, but its short interest ratio was just about 1.2 days, which is the amount of time it would take for short-sellers to cover their position.
With anything over seven days considered a lot, it is still relatively easy for short-sellers to unwind their position and cover it to stem the bleeding.
Unlike GameStop, there’s no continuous upward pressure on its shares, and that goes for a number of other stocks that have also seen their stock price benefit from a short squeeze.
A tale of two shorts
GameStop’s stock can still fall back even if it doesn’t issue more shares, particularly as attempts are being made to thwart the coordination of retail investors in buying the retailer’s stock.
But with the fundamental operations of AMC Entertainment and GameStop being completely different, their financial situations diverging, and the structural impediments of how their stocks are sold short, it’s easy to see why the theater owner is crashing while GameStop still has the ability to climb.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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