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GameStop Slumps As Short Sellers Quit Bets, Squeeze Play Recedes

Short interest in GameStop has slumped to less than 10 million shares as Wall Street pros abandon bets against the money-losing video game retailer.

GameStop  (GME)  shares extended decline Tuesday, falling the most in nearly a month, as pro traders pare bets against the money-losing video game retailer, removing a key foundation of the stock's incredible rise.

Short interest in GameStop shares, a figure that represents bets against the stock on Wall Street, fell below 10 million at the end of last week, or just over 18% of the outstanding float. That's down from around 57.8 million shares, or 113.3% of the float, when short-selling against the group peaked and Reddit-fueled buyers took the stock to a record high of $483 per share.

As the so-called short squeeze, which has tagged hedge funds and other pro traders with more than $11 billion in year-to-date losses eased, however, shares still managed to hold onto those early February gains after the group said it created an inter-company committee, which includes activist investors and  (CHWY)  founder Ryan Cohen, to "identify initiatives that can further accelerate the company’s transformation" that includes hiring a chief technology officer, two executive to lead e-commerce and fulfillment functions and forming a search committee for a new CFO.

"While Cohen’s involvement in business is positive, it wasn’t unexpected, and neither is it such large news to drive the stock price to double," said analysts at research group Trefis. "Now, while the January surge in GME stock was driven by a short squeeze, the overall short position has dropped meaningfully from as high as 68 million shares in January (vs. total company’s float of 45 million shares) to 11 million currently."  

GameStop shares were marked 12.6% lower in late-morning trading Tuesday and changing hands at $192.30 each, paring the stock's 92% increase over the previous five trading days.

Short sellers are investors who bet against a certain stock by selling it by borrowing them from another investor and selling them on various exchanges or platforms in the hope of buying them back at a lower price in the future and pocketing the profits.

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Wall Street pros argue that short sellers provide several key functions in the market, including price discovery and additional liquidity, while critics counter that some rely on "predatory" practices that can damage companies and wipe-out small investors.

In the case of GameStop, options markets have been the catalyst for share price moves against short sellers in what is often referred to as a 'gamma squeeze'

In the simplest terms, a call option buyer has the right, but not the obligation, to buy shares of a company at a certain price at some specified point in the future.

He or she might think owning a call option on GameStop with a $250 strike price when shares are trading at $150, is a better way to play the stock's momentum.

Options sellers, meanwhile, will often buy the underlying stock in the open market as its price moves higher, in order to hedge their risk, creating a virtuous, but potentially ephemeral, a circle of ever-higher prices. 

When short interest in a company declines, the 'gamma' volatility declines with it, leave the stock to often lurch lower as the need to 'cover' bets in the options market recedes. 

"Though the stock can defy all estimates and move in any direction, we don’t see a significant leg to this rally given the lack of fundamentals" Trefis noted. "Also, based on our machine learning analysis of trends in the stock price over the last few years, we believe that there is a strong chance of a decline in GME stock over the next month."