SNAP: Shorting through options

Published on: Mar 08 2017 by John Critchley

By: John J. Critchley, Jr.

Senior Options Specialist and Option Principal

The SNAP Inc. $SNAP  IPO rocketed out of the gates on its first day of trading making a 44% move. The stock has since retraced some of these gains, but the newest tech darling is still up substantially from its IPO price and is valued an astronomical P/E.  Do you want to short this pricey IPO, but don’t want to borrow the stock at an exorbitant rate? What’s the investing public to do?  Use Options.

On March 10th, the options exchanges will offer $SNAP options.  In the past, it might be months before a hot IPO has options listed on them.  Nowadays, in the 24/7 interconnected investing world of today, there is no patience; no waiting for the ‘right’ time’.  When these options become eligible for listing in a little over a week, they will trade.

Many option market makers will tell you that the longer wait in the past was absolutely necessary as options pricing is fundamentally based of implied volatility. Implied volatility is based off the historical (real) volatility of the underlying and such a short time frame makes it quite difficult to accurately and fairly price the options.

This pricing difficulty consequentially leads to wider markets and potentially less favorable fills for the retail trader.  As long as the retail customer is aware of this ‘pricing’ dilemma and accepts this mispricing possibility, then the trading in SNAP options presents a compelling way for the retail to express their fundamental view on the biggest tech IPO in many years.

For an example of a stock that was hard to borrow after its IPO, one has to look no further then another social media high flyer; $LKND. The float in LKND was initially under 10 million shares.  At the same time, there were quite a few investors that believed the stock was massively overpriced, and thereby want to be short the underlying.  The combination of a low float with a perceived overvalued stock resulted in an underlying that was extremely hard to borrow and therefore short.

Why care about the cost of borrowing SNAP?  The simple answer is that it will get priced into the options in the form of Reversals and Conversions and affect the pricing of synthetic options.

What are Synthetic options?

A synthetic short is a combination of a short call and long put.    A synthetic long position is a combination of a long call and short put.    The basic formula is:   Call minus (-) Put=Underlying Stock Price minus (-) Strike Price plus (+) Cost of Carry.   This simple formula lets anyone create synthetic long or short stock out of just puts and calls.

Why Options?

You can synthetically sell 1000 shares of SNAP by selling 10 calls and buying 10 puts of the same strike and expiration.  When interest rates are so low, the price of selling the calls minus the price of buying the puts, plus the strike price equals the synthetic price you have sold the underlying.

Sounds good. But hold on a second, the rate to borrow (cost of carry) of SNAP will not be low. To the contrary, it will be sky high.  After $LKND was listed and was so hard to borrow, the cost of carry for the underlying reached an absurd 50%.  The consequence of this high rate is that the retail customer will pay more for the puts and receive less premium for the calls. 

If you want to short SNAP and cannot borrow the stock or don’t want to pay a higher borrowing rate, consider using the synthetic short underlying strategy describe above.   But be forewarned; the put prices will be extremely expensive relative to the call prices.

Let’s see what happens on Friday.  Stay tuned………

 

Notes: Prices quoted where the prices at time of submission and do not reflect current market prices.

 

Disclaimer


We are not liable for any trading decisions made by any reader. NO advice is given or implied. The information offered in  this article is for demonstration purposes ONLY and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options .

Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.

Past performances DO NOT guarantee future results. Please consult with your own independent tax, business and financial advisors with respect to any trade. We will NOT be responsible for the consequences of anyone acting on this purely demonstration material.

 

 

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