First, the tactical short, whereby you take advantage of a temporary overpricing of the stock. This can be day trading -- in and out in as little as 15 minutes.
If you are an experienced trader, this should be second nature and we will not dwell on it.
However, the second type of short selling in initial public offerings has been very lucrative lately. This is the position short, whereby you are take a large position and hold it.
To do this, you have to be convince that the IPO is wildly overpriced. Usually it will be overpriced for one of two reasons: (1) the underwriters have succumbed to the company's demands that they sell the stock at some wild overvaluation, or (2) the public demand has reached a frenzy and the public is overpricing the stock.
The advantage to the short sellers in selling initial public offering is that the company and the underwriters will have whipped up demand for the issue, created a market to sell into.
The danger to the short is if the underwriter is able to support the issue and move it up. If the underwriter opens the stock at a modest premium to the offering price, and then the short starts selling only to find the stock moving up, the short has lost money. It is a matter of judging the market, and that comes with experience.
Take a look at Zynga:
I regarded Zynga as an overpriced dog at the issue price. When you compared it to the other social underwritings based on users, revenue, etc. it was clearly overpriced.
The underwriter did a great job supporting the stock and a brilliant research report helped push the stock up from the offering price of $10 to a high nearly 50% higher.
Alas for Zynga, the flaws in the business caught up with it, no doubt publicized by those with a short interest in the stock. The stock is now so low, it is a fallen angel, down to about 25% of the issue price.
It is not uncommon to see an underwriting fall maybe 50%, as most of them are over promoted to begin with, but to fall to 25%, that is a very sad comment on the company, the underwriting and on the investors who paid up for it.
My guess is that the stock may recover from this low price, but this is still not a stock I would look at buying.
Facebook was a screaming short -- too much hype, too little reality at that price. My spreadsheet also showed massive overvaluation compared with other such stocks. I told a social media client if he wanted to do an underwriting, he had to go public before Facebook hit the market as FB would take all the air out of the market -- all the money would go into Facebook.
The result was worse than I thought due to the company stuffing the market with all the stock that was demanded and leaving the market without any buyers in the aftermarket.
There were a ton of shorts and reportedly it was hard to borrow the stock so you could short it.
As you can see, this was a gratifying experience for the shorts.
With any IPO short, when the stock falls to something like 50% of the offering price, it is time to look for the exits and cover.
Alternatively, you can just play trend lines to lead you to the best return on investment per unit time.
All of this starts with a spreadsheet analyzing pricing, and I will show you one shortly in a new post, with complete explanation of how it works and how to use it.
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