Short sellers profiting from Facebook shares - Image Courtesy Facebook
It was bound to happen. One of the greatest things about the stock market is there are two ways you can make money. You can either buy low and sell high, which is the most common way people make money on the stock market; and there is also another way, which is, you could sell high and buy back low.
How does this work?
This is called short selling, and short sellers would borrow shares from market makers like investment companies. They would borrow the shares at high price, sell it and then wait for the stock price to sink. Once it has sunk low enough, they then buy back the shares. The difference is their profit. They have to of course replace the stocks that they borrowed from the market makers. This is a very accepted, although not universally respected way to make money off the stock market. No surprise, considering that you are dancing on the graves of companies that are seriously sick. In essence, you are making money off the misfortune of a publicly traded company. Be that as it may, short sellers had a field day when Facebook, the much-loved and much-hyped social networking site, debuted and stumbled right out of the gate. Its shares hit the 52-week high on its first day of over $40 a share. It has since flirted with $25 a share. This is a nice little spread for critics, skeptics and outright haters of the stock or doubtful that Facebook would live up to the hype. That’s why there is quite a bit of short selling activity for Facebook stock. Indeed, of the 421 million shares that the company issued in its initial public offering, 8.1% of that volume was sold short by May 31; which is about 2 weeks after the stock started trading. It is obvious that Facebook is facing a lot of downward pressure from its market skeptics. The “smart money” is not betting on Facebook achieving the same success as Google had, several years back. Indeed, in the same class of stocks as Facebook or social networking stocks, only LinkedIn is doing quite well. Other companies like Groupon and Zynga have taken quite a beating. Short sellers are continuing to pile on as the initial barriers to selling Facebook stocks disappear. One of the most crucial barriers is the interest paid on borrowed stock. The stock was so popular as a short candidate that the cost of borrowing its stock soared to 40% annual interest rate. Interestingly enough that interest rate has sunk down to 0.6% which indicates that there is a lot more stock now available for shorting.
What does the future hold for Facebook stock?
It has been on an acquisition roll lately. It’s still unclear how this would impact its bottom line. There are even rumors that Facebook is looking to launch its own smartphone. Regardless, it appears that Mark Zuckerberg and the leadership at Facebook are well-aware of the systemic challenges that face their companies and they could at least be credited with being proactive in trying to find work-around for these problems. Still, when it comes to actually investing in Facebook, investors need to keep in mind that the lock-in period expiration for this stock is still months away. Normally, when a fresh IPO stock’s lock-in period expires, its price drops because of the huge amount of shares entering the market as early investors, company founders and early employees cash-in on the stock. Also, Facebook’s quarterly earnings should roll in, and it should give a better picture as to where the company is headed. Pay special attention to its growth rate and most importantly its ability or lack thereof to monetize its mobile traffic.