Here’s Why Shorting Groupon May Be Dangerous

Groupon Inc (NASDAQ:GRPN) is a hot target for short sellers. The popular daily deal company is losing money, changing accounting practices, and its unconfirmed business model faces competition from Google (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN). However, short sellers may need to wait. Due to Groupon’s tiny share float, shares are just too expensive right now.

Groupon (NASDAQ:GRPN) sold a stake of approximately 6 percent in its initial public offering, which means there is not much stock available for short sellers. Short sellers borrow shares before they can purchase them. If the stock drops they can buy it back at a lower price, return them to the lender, and the difference is their profit. However, some brokers are charging an annual rate of 90-100% to borrow Groupon stock — that’s a highly unusual cost.

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Investors would need to see the stock go close to zero for a yearlong bet to make money with those fees. Fred Moran, an analyst at Benchmark Co. says, “It would be very premature and highly risky to consider shorting Groupon (NASDAQ:GRPN) soon after the IPO. It’s very difficult to borrow the stock on a newly issued security and it has a very low float.” Jeff Matthews of Ram Partners agrees saying, “I’m not looking at it yet because of the borrow and float. Also, they have some smart guys there. It could become a legit business, although I doubt it. So waiting and watching.”

Andrew Left of Citron Research likened the risk of shorting Groupon (NASDAQ:GRPN) to betting against LinkedIn Corp. (NYSE:LNKD). LinkedIn went public in May with a float of less than 10%. Its shares more than doubled the first day but the next month lost most of those gains. By July, LinkedIn was up about 75 percent. Such fluctuations can leave short sellers with large losses. Left says, Groupon might be an eye-catching short at some time in the future, but “right now it could go higher too easily. The stock market is a game of supply and demand, not fair when there is no float.”

Another option to bet against the company is to buy put options. This would give the holder the right to sell shares by a certain date at a predetermined price. On Monday, the firsd day of options trading, the price of put options on Groupon (NASDAQ:GRPN) was high. Put options that expire in December and carry a $24 strike price were priced at about $3. Factoring in that premium, an investor would be betting on shares to fall below $21. Call options, a bet on a stock rise, traded at a $1.50 premium.

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According to Ryan Detrick, senior analyst at Schaeffer’s Investment Research, “Everyone is expecting the stock to slide and there is definitely a higher skew to put activity, but you need to really believe that there will be a drastic move on the downside to buy puts at this premium.”

Even though there is high risk with shorting Groupon (NASDAQ:GRPN), there is still a demand to do so. According to Quadriserv AQS, a large amount of Groupon stock was was lent at a 90 percent negative rebate last Thursday.