When are short selling accepted for IPOs?


Shorting a stock can be a good trading strategy if an investor expects the value of a stock to decline. It is also a risky trade since, in theory, the loss on a short trade can be infinite since the price of a share can go up as much as there are numbers. Any stock can be short.

When a private company goes public and sells its shares on an exchange for the first time, the process is known as an initial public offering (IPO). Stocks that go public after an initial public offering can be shortened on initial trading, but it is not an easy thing to do at the beginning of the offering. First, you need to understand the process of IPOs and short selling.

Key takeaways

  • An initial public offering (IPO) occurs when a private company offers its shares to the public in a new share issue.
  • Short selling occurs when an investor borrows a stock and repays it in the future, in the hope that the share price will fall to make a profit.
  • Lending institutions need an inventory of the shares before they lend them to an investor.
  • An initial public offering often offers a small number of shares, which limits what can be borrowed for short trading.
  • The SEC prohibits IPO underwriters from lending shares for a short sale for 30 days.

Initial public offering (IPO)

An IPO occurs when a company goes from private to public. The company and an insurance firm will work together to price the offering for sale in the market and promote the IPO to the public to ensure there is interest in the company. Generally, the shares of the company are sold at a discount by the company to the subscriber. The underwriter then sells them on the market during the IPO.

Short sale

When an investor shorts, he essentially borrows a share and repays it in the future. If you do this, you expect the stock price to fall because you want to sell high and buy low. For example, if you sell a stock short at $ 25 and the share price falls to $ 20, you will get $ 5 per share if you buy the stock at $ 20 and close the short position.

Challenges of short selling with IPOs

In order to sell a stock short, you generally need to borrow it from an institution such as your brokerage firm. To borrow it, they need an inventory of this stock. This is where the difficulty with IPOs and short selling can arise.

An IPO generally has a small number of shares in initial trading, which limits the number of shares that can be borrowed for short sale purposes. On the day of the IPO, two main parties keep an inventory of the shares: the underwriters and the institutional and retail investors.

As determined by the Securities and Exchange Commission (SEC), which is in charge of regulating IPOs in the United States, IPO underwriters cannot lend shares for a short sale for 30 days. On the other hand, institutional and retail investors can lend their shares to investors who want to sell them short.

However, probably only a limited number of shares would be available on the market, as the company had only just gone public and the shares may not have been fully transferred. In addition, there may be an unwillingness among investors to lend their shares to sell them short.

The bottom line

While there are regulatory and practical obstacles to short selling shares of an IPO, primarily through limitations placed on underwriters, short selling a company on the day of its IPO is still possible if institutional or retail investors who have bought the shares lend them for short sale. However, the amount of shares available for sale short and the willingness of investors to do so immediately is small.

www.investopedia.com

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Mark Holland

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