director of research, Astec Analytics, SunGard's capital markets business

25
May
2012

A lens on Facebook’s first days of trading

Contributor:

Facebook’s problems on its first day of trading had many brokers concerned about their ability to borrow shares on Wednesday to settle short sales. Therefore, on Tuesday, as some institutional investors received shares early in the allocation process, brokers borrowed 26 million Facebook shares at a costly 40% annual interest rate. However, on Wednesday, a flood of lendable shares sent borrowing costs for Facebook shares down 80%. Another 28 million FB shares were borrowed at these lower rates on Wednesday.  On Thursday, brokers borrowed another 10 million shares but returned 9 million, for a net additional 1 million shares borrowed.

When options trading begins in Facebook shares next week on the Chicago Board Options Exchange (CBOE), market makers will need to borrow and short Facebook shares in order to hedge the options that they write. If the supply of lendable Facebook shares was tight and borrowing costs were high, options would be priced more richly and market makers would have a bit harder time facilitating a market because it would be more difficult to find borrowable shares. The CBOE usually waits longer after an IPO to begin trading options, and given the problems at NASDAQ on Friday, one would think that the CBOE would be extra cautious. An improvement in the ability to borrow shares in the securities lending market should ease some of those concerns.

Shorting a high P/E stock such as Facebook, despite the recent correction in its share price, is still dangerous because long investors are purchasing shares to participate in future growth, which is currently indeterminate. It’s hard to imagine it now based on the problematic first week of trading, but a piece of unexpected good news could cause investors to jump back in and send Facebook shares shooting upward. Short sellers must also be cognizant of macro-level developments, particularly at the central bank level, that may encourage savers to rotate more money into risky assets such as Facebook stock. On the other hand, a deflationary environment could set up a high P/E stock such as Facebook for a swift fall.

Further in the future, when indexes begin to include FB, there will be support from index tracking funds. But S&P requires that “initial public offerings should be seasoned for 6 to 12 months before being considered for addition to an index.” Russell and Wilshire may add FB sooner than that, but it’s difficult to quantify the impact of index inclusion, especially when paired with bearish events that will take place in the future, such as the end of the lockup period when the overhang of stock is dumped onto the market.

Stay tuned, as this story is only beginning.

While you’re here…

 

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