The GameStop short squeeze: Put–call parity and the effect of frictions before, during and after the squeeze

• Published date: 01 May 2023
• Author: Jimmy E. Hilliard,Jitka Hilliard
• Date: 01 May 2023
• DOI: http://doi.org/10.1002/fut.22405

Received: 24 March 2022

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Accepted: 12 February 2023

DOI: 10.1002/fut.22405

RESEARCH ARTICLE

The GameStop short squeeze: Put–call parity and the effect

of frictions before, during and after the squeeze

Jimmy E. Hilliard |Jitka Hilliard

Department of Finance, Auburn

University, Auburn, Alabama, USA

Correspondence

Jimmy E. Hilliard, Harbert Eminent

Scholar, Department of Finance, Auburn

University, Auburn, AL 36849, USA.

Email: jim.hilliard@auburn.edu

Abstract

The short squeeze in GameStop attracted worldwide attention and resulted in

congressional hearings. The increase in GameStop stock from an opening price

of $21 on January 26 to an interday high of $483 on January 28 was not the

result of obvious fundamental earnings prospects. Buying pressure from

investors on a social media site accompanied by short covering, resulted in

the stratospheric ascent of stock price. We use put–call parity to investigate the

related issue of the no‐arbitrage violations before, during, and after the

squeeze. We do not find evidence of abundant free money after accounting for

short selling frictions.

KEYWORDS

arbitrage, GameStop, market frictions, put–call parity, short‐squeeze

JEL CLASSIFICATION

G14‐Information and Market efficiency

1|BACKGROUND

The short squeeze on GameStop stock (GME) attracted worldwide attention and resulted in hearings in the US

Congress. The hearings focused on the role of short‐selling, payment for order‐flow, and the suspension of trading in

GameStop stock on January 28, 2021. The increase in GME from an opening price of $21 on January 26 to an interday

high of $483 on January 28 was not the result of obvious fundamental earnings prospects. Instead, buying pressure was

created in part by an orchestrated effort dominated by small investors on the online WallStreetBets forum, a

subplatform on the Reddit social news website (Reddit.com). Their demand, accompanied by short covering, resulted

in a rapid and large (23‐fold) increase in stock price. According to IHS Markit (ihsmarkit.com), GameStop short interest

was 114% of free floating shares in mid‐January, falling to 39% on February 1.

1.1 |Literature

How well did the market function during this crisis period

˙? Jones et al. (2021) examined the effect of brokerage

restrictions on stock returns and market quality for GameStop and 37 other heavily shorted firms. They found

significant negative stock returns and spikes in implied volatility when trading was restricted. They also found that

J Futures Markets. 2023;43:635–661. wileyonlinelibrary.com/journal/fut

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided

the original work is properly cited.

© 2023 The Authors. The Journal of Futures Markets published by Wiley Periodicals LLC.

equity bid‐ask spreads were not adversely affected by the restrictions. There was some transfer of volume from the

equity markets to option markets. The Bryzgalova et al. (2022) paper is a comprehensive documentation of retail

trading with focus on short term options, price improvement, and payment for order flow. One of their many findings

is that retail investors prefer cheaper, weekly options.

There were reports on the GameStop squeeze by The Financial Services Committee of the House of

Representatives and by the securities and exchange commission (SEC). The Financial Services Committee Report

“Game Stopped: How the Meme Stock Market Event Exposed Troubling Business Practices, Inadequate Risk

Management, and the Need For Legislative and Regulatory Reform”is a 138 page report that includes a list of

findings, implications and possible regulatory reforms at the SEC, Financial Industry Regulatory Authority

(FINRA), and the depository trust and clearing corporation (DTCC) that are needed to increase resiliency,

transparency and access.

1

The SEC report “Equity and Options Market Structure Conditions in Early 2021”

investigates GameStop and market functioning during the squeeze. One of their conclusions is that the rapid run‐

up in GME stock is due in part by demand to cover but primarily because of concerted buying by small investors

in the Wall Street Bets online community. Mitt et al. (2022), with access to additional data, challenge this part of

the SEC report, suggesting that there was huge demand for stocks due to short covering, the delta squeeze, and

the gamma squeeze. The delta squeeze is the demand for stocks by market makers covering short call option

positions. The gamma squeeze refers to additional stock demand due to demand from the delta squeeze.

Because of clearing issues, the settlement cycle was addressed by a number of reports and academic papers. Angel

(2021) recommends that the T+ 2 settlement cycle be shortened to reduce risk and collateral requirements and that the

frequency of short interest disclosure should be increased to daily from the current biweekly reporting. Fusari et al.

(2022), using a put–call parity (PCP) framework, identified the GameStop stock as being in a significant and persistent

bubble between December 2020 and January 2021.

1.2 |PCP and the short squeeze

We use PCP to investigate the related issue of the arbitrage efficiency in GameStop trading before, during, and

after the squeeze periods. Violations of PCP is frequently attributed to short selling constraints. See, for example,

Battalio and Schultz (2011), Grundy et al. (2012), and Ofek et al. (2004).Hendershottetal.(2013) review the

literature on short‐sale bans and report that their effect is pervasive in financial markets. In contrast to these

studies, we look at the possible failure of PCP in the context of short selling excesses, that is, instead of short

selling regulatory frictions, we study the effect of a market frictions on PCP before, during and after a short

squeeze.

The GME squeeze represents in microcosm many of the issues now confronting regulators, such as the gamification

of investing, new technologies, payment for order flow and investor protection. Examination of market efficiency in the

turbulent short squeeze regime provides a useful benchmark for regulators.

While the focus is on GameStop, in Section 6we examine PCP spillover effects on meme stocks Bed, Bath and

Beyond (BBBY), Virgin Galactic (SPCE), and FTX Tokens.

2

1.3 |Preview

We use stock price/volume and stock price/option volume, Figures 1and 2, respectively, to focus the analysis on

presqueeze, squeeze and postsqueeze periods. We define periods as follows: presqueeze—January 4 to January 21,

squeeze—January 22 to February 10, and postsqueeze—February 11 to February 26. Breakpoints were defined by

significant changes in the volume of trades and stock prices. Violations are recorded when PCP strategies have positive

returns after adjusting for bid‐ask spreads. There are relatively more violations in the presqueeze and squeeze periods.

The greatest number of violations are found in the PCP branch that requires stocks to be sold or shorted. There is a

greater percentage of violations in long maturities. We also model errors as a mean regressive process and find that the

1

The FINRA is a government‐authorized not‐for‐profit organization that oversees US broker‐dealers. DTCC subsidiaries National Securities Clearing

Corporation (NSCC) and Fixed Income Clearing Corporation (FICC) deliver clearing services across the U.S. equities and fixed income markets.

2

The term “meme”stocks refer to companies that gain viral popularity due to highlighted social sentiment originating at a social media platform.

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HILLIARD and HILLIARD