Explained: Can GameStop-like scenario happen in Indian market?

Updated : January 29, 2021 06:32 AM IST

In India, the SLB window does not see much activity relative to the overall trading volumes

Wall Street has a thriving market for lending and borrowing of shares.

The spectacular rally in shares of companies like GameStop, AMC Entertainment and Blackberry on Wall Street has led to talk about a shift in the power equation, with small investors turning the screws on professional short-sellers.

The rally in these shares—as much as 800 percent in the case of GameStop—has resulted in severe financial losses to many reputed money managers, who short-sold the stocks thinking they were overpriced.

In each of these cases, traders active on online-forums talked up the stocks, and surprisingly found plenty of takers, propelling the stocks to fantastic levels. Before we get into a discussion on whether such a scenario is possible in India, let us look at what caused the price of GameStop to flare up.

Bargain buying through out-of-money options

Many traders started buying out-of-money call options in GameStop. These options were available cheap, since the writers (or sellers) of such call options are betting that the stock price won’t rise much during the tenure of the contract. But more traders started buying out-of-money call options. Typically, writers of such contracts hedge their position by buying shares of the company from the open market. When too many call option writers start buying the shares, the share price starts rising. This sets off a cascading effect, because the momentum in the stock price attracts more buyers, causing a further rise in price, and thereby more buyers, resulting in a self-fulfilling prophecy.

Is a similar situation possible in stocks listed on the BSE and NSE?

In theory, yes. But market conditions in the US and India differ widely. For instance, Wall Street has a thriving market for lending and borrowing of shares. Short sellers can borrow shares for a fee, sell them if they feel the stock is overvalued. In India, the Securities Lending and Borrowing (SLB) window does not see much activity relative to the overall trading volumes. The reason for a shallow market for stock lending and borrowing is partly cultural as well, given that short-sellers have been traditionally viewed as destroyers of wealth, and hounded by regulators in the past.

How then do short sellers go after stocks perceived to be overvalued?

They can do that through the futures and options (F&O) route. They can either sell the futures, sell call options, or buy put options. However, given the stringent margin requirements, F&O is not a segment for retail investors. It is mainly for high networth traders and institutional investors.

Can a stock rise as much as 800 percent on the BSE or NSE within a month?

Not possible because of intra-day circuit filters, which limit the maximum fall or rise for stocks to 20 percent over the previous day’s close. If the stock continues to hit the upper end of the circuit filter for three or four days in a row, the stock exchanges keep progressively reducing the intra-day limit to 10 percent, 5 percent and 2 percent. The intra-day circuit filter is not applicable for stocks in which futures and options are allowed. But even here, there is a high probability that SEBI or the exchanges will intervene if the extreme price movement persists.

Can retail investors in India beat professional money managers at their game, like in the case of GameStop?

Theoretically, they can, but only for a brief period, and in select stocks. Sometimes stocks rise because of frenzied interest from retail investors even after fund managers have sold the shares, perceiving them to be fairly valued or expensive. But institutional investors have staying power, which retail investors lack. In large-cap stocks, it is next to impossible for retail investors to beat professional investors. In midcaps and small caps, there is only so much positions that can be taken up through the F&O route. Besides, promoters of many midcap companies dabble in their own stock, in collusion with market operators and at times, even with fund managers. It is hard for retail investors to win, if they are up against promoters and operators who work as a team.

Explained: Can GameStop-like scenario happen in Indian market?

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