One of the embedded costs to shorting is the need to borrow the shares first on margin. Usually it’s a relatively (although not inconsequential) rate… but with the scarcity of shares available for recent IPO Groupon (NASDAQ:GRPN), the borrowing costs are so high on an annualized basis – you’d actually have to see the stock go to zero to make a profit. (Assuming borrowing costs don’t fall over time, which they will as more shares are unlocked down the road) Of course, any institution shorting right now is probably doing it on a much shorter time frame than a year – due to cost alone!
- On paper, Groupon Inc appears to be a juicy target for short sellers: it loses money, it has changed its accounting twice, and its unproven business model faces competition from Google (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN). But the shorts may have to wait as betting against the daily deals website is just too expensive right now because of its tiny share float.
- To make money shorting the $15 billion company, which went public earlier this month, investors would have to see the stock go close to zero for a year-long bet. “It would be very premature and highly risky to consider shorting Groupon soon after the IPO,” said Fred Moran, an analyst at Benchmark Co. “It’s very difficult to borrow the stock on a newly issued security and it has a very low float.”
- Groupon sold a stake of about 6 percent in its initial public offering, one of the smallest in the past decade. That means there is little stock available for short sellers, who have to borrow shares before they can sell them. If the stock drops, they can buy it back at a lower price, return them to the lender and pocket the difference as profit.
- A scarce supply had some brokers charging an annual rate of 90 percent to 100 percent last week to borrow Groupon stock, according to two hedge fund managers, one independent trader and one prime broker. They spoke on condition of anonymity to preserve their counterparty relationships.
- A 100 percent rate, or negative rebate as it is known, means a trader has to pay $20 to borrow a $20 stock for a year. In this instance, Groupon stock would have to drop to close to zero within a year for a short seller to break even. So traders are only shorting the shares for very short periods, such as a few hours, or avoiding the trade all together.
- Another way to bet against the company is to buy put options, which give the holder the right to sell shares by a given date at a particular price. The cost of put options on Groupon were high on Monday, the first day of options trading. 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, suggesting more demand for the stock to fall.
- “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,” said Ryan Detrick, senior analyst at Schaeffer’s Investment Research.
Trader Mark is the author of Fund My Mutual Fund.
Further Reading: Here’s Why Shorting Groupon May Be Dangerous>>