Recently, we’ve heard the term of “infinity squeeze” with respect to Gamestop (GME).  The origins of where this term came from the Volkswagen, VW Infinity Squeeze in 2008.  We’re going to revisit that event in the blog.

The term “infinity squeeze” was invented to describe what happened with one of the biggest short squeezes of all time, which happened with Volkswagen in 2008.

The short version of the Volkswagen story is that Volkswagen, like many other auto companies, appeared headed straight for bankruptcy as a result of the global financial crisis back in 2008.

It was during the middle of the worst financial crisis since the Great Depression, and Volkswagen was increasingly being viewed as a potential bankruptcy candidate.  In other words, Volkswagen was viewed as an exceptionally attractive short candidate.  Because the company’s prospects were dire, hedge funds were heavily short Volkswagen shares, seeing bankruptcy as almost a lock.

The VW infinity squeeze seemed entirely counter intuitive at the time.  And that is exactly the point.  All infinity squeezes are the result of heavy over-shorting of shares which then become difficult or impossible to cover.  Such aggressive over-shorting only occurs when the bear thesis against the fundamentals is conclusively strong and very well disseminated. In other words, stocks which appear to be the “best short ideas” are also the ones which often end up being most likely to see the most violent short squeezes.

In fact, as the financial crisis unfolded in 2008, the entire auto sector was considered to be a highly attractive short trade.  As a reminder, up until 2008, General Motors had been the largest automaker in the world for more than 70 years and had over 200,000 employees.  But by December 2008, GM was being bailed out by the US government and by 2009 GM had entered bankruptcy.  Automaker Chrysler would file for bankruptcy at roughly the same time in 2009.  Against this backdrop, in late 2008 a short bet on troubled Volkswagen seemed like an absolute no brainer.

But then, on Oct. 26, 2008, a surprise announcement was made by Porsche, another German auto company that had secretly acquired 74% of Volkswagen’s share float.

After the Porsche announcement, it suddenly became clear: The hedge funds with Volkswagen shorts were now completely caught out. If Porsche refused to sell, they would have to “buy back” their short positions at almost any price.

It was dubbed an “infinity squeeze” because, with no way to buy back shares, the shorts are at the total mercy of the longs, which means the price of a heavily shorted stock can go almost anywhere — and with Volkswagen, it did.

For a brief window of time, the VW infinity squeeze turned Volkswagen from a near-death bankruptcy candidate into the most valuable company in the world. The hedge funds that were short lost an estimated $30 billion, and Porsche made eight times more money on trading that year than it did from selling cars.

Over the longer term, VW’s share price ended up falling significantly.  And over the long term, this outcome was certainly quite predictable.  But from a financial standpoint, investors who shorted VW shares at what appeared to be the optimal time suffered very steep trading losses.  Ultimately, the only thing that matters to investors is realized gains and losses.  This was the origins of the VW Infinity Squeeze.

Hopefully this helps you gain some insight into what an infinity squeeze is and what may happen to Gamestop (GME).

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