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Do Hot IPOs Equal Hot Options Trading Opportunities?

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Despite the other challenges we’ve faced, 2020 has been an extraordinary year for Initial Public Offerings. The surge in popularity of direct listings and the Special Purpose Acquisition Company (SPAC) have accelerated the pace at which new shares have been brought to the public.

In a traditional IPO, the company is selling shares to the public on an exchanges for the first time ever and engages the services of one or more investment banks to serve as underwriters of the offering in exchange for a combination of fees and shares. The shares being sold are newly created and the proceeds of the offering flow directly to the company.

A direct offering is similar, except that no new shares are created. The shares being traded are sold by existing shareholders – most commonly company founders, early employees and Venture Capital investors who provided pre-public financing in exchange for equity. Spotify (SPOT - Free Report) and Slack (WORK - Free Report) are examples of high-profile and successful direct offerings.

There’s also the option for a company to avoid the underwriting process by auctioning shares directly to the public, generally using a dutch-auction process in which all prospective investors buy shares at the lowest price that will satisfy the entire number of shares floated. This is fairly rare with Alphabet (GOOG - Free Report) – formerly Google – the only notable recent example of a successful public-auction offering, and that was way back in 2004.

Finally, 2020 has definitely been the “Year of the SPAC.”

A SPAC is a company that goes public before they have any significant business operations, making the financial disclosures relatively simple. The money they raise in the offering is earmarked for the acquisition of one or more private companies, bringing those companies to the public markets without them having to undertake the traditional IPO process themselves.

Though the process generally involves a slightly higher level of dilution for shareholders, it’s much faster than filing for an IPO, allowing private companies in a hot industry to raise cash and have their shares traded publicly while the industry is still hot. The practice is completely legal and can serve to improve on the efficiency of the IPO process, but investors should be aware that what they gain in expediency, they may lose in transparency. Caveat Emptor.

2020 Bonanza

Through November of 2020, there have been 194 traditional IPOs raising $67 billion and 200 SPAC offerings raising $64 billion – and that’s before two HUGE traditional IPOs this week.

On Wednesday we saw food-delivery giant Doordash (DASH - Free Report) price its offering at $102/share, begin trading at $182 and close its first session at $189. After one day as a public company, Doordash now sports a market cap of almost $60 billion. That’s about the same as General Motors (GM - Free Report) . The company that arranges for a driver to bring you sandwiches is worth as much as the 100-year-old company that manufactures the automobiles it arrives in.

Thursday saw the long awaited IPO of Airbnb (ABNB) and the results so far have been even more impressive. The deal was priced at $68/share which would imply a total market cap of $47 billion. In the first few hours of trading, they soared to over $150 and a valuation well over $100 billion.

In 2019, Airbnb lost $674 million on revenues of $4.8 billion. So far in 2020, they’ve lost $697 million on revenues of $2.52 billion.

For comparison, Hilton Worldwide Holdings (HLT - Free Report) has a market cap around $30 billion. In 2019, they netted profits of $881 million on $9.5 billion in total revenues. Though the Covid-19 pandemic has hurt hotels, HLT is still expected to grind out a modest profit in 2020 and to bounce back with a net of $1.78/share in 2021 – 65% of that 2019 peak. And the stock pays a dividend!

All the excitement and price volatility makes these recent hot IPOs popular with the options trading crowd. But when can you trade options and execute your strategies for capitalizing on futures movement in these names?

Soon.

There are five basic rules from the Options Clearing Corporation (OCC) for listed options on the nation’s options exchanges.

-The stock must be listed on a National Market System exchange.

-There must be at least 7 million shares outstanding.

-There must be at least 20,000 shareholders.

-The stock must have more than 200k shares in average daily trading volume.

-The shares must trade above $3/share for five consecutive days.

Because the recent hot IPOs easily satisfy all of these requirements except for the “five consecutive days” of trading, that’s the only part you’ll have to wait for.

Including the day of the offering, options will generally be listed one calendar week later.

What to Trade?

More than ever, I’m going to warn extreme caution when jumping into options trading on new issues. Not only are the share prices volatile, implied volatilities themselves tend to be volatile as market makers adapt to the trading patterns in each individual stock. Significant price moves in options are attractive to traders, but can also cause significant and swift losses.

If you wanted to buy these stocks but feel that they’ve come too far, too fast to dig in now, you might consider selling puts with a strike at the price where you’d be willing to buy. You collect what tends to be a juicy premium on high implied volatilities and in the worst-case scenario, you also end up buying the stock at your target price.

Whatever you do, consider reducing your size considerably. There’s absolutely nothing wrong with trading a one-lot. You’ve heard me say this before, but it bears repeating. If you trade small and you’re right, you still make money – even if it’s a bit less than you were hoping for.

If you trade big and you’re wrong, you might blow yourself right out of the game.

The stakes are high with new issues. Make sure you live to trade another day.

-Dave

Want to apply this winning option strategy and others to your trading? Then be sure to check out our Zacks Options Trader service.

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