There’s a major downside to trading stocks now that every man, woman and child has a brokerage account. In the old days, you could pretty much short any stock you wanted. However, now that shorting is as easy as making a TV dinner, at times you might not even be able to find shares to borrow from your broker to short. Shares that are particularly hard to borrow might even come with a fee attached — usually expressed as an APR you must pony up. If that APR is too high, it can really cut into profits.
I’ve run up against this problem several times over the past few years. However, there is a solution, and it can be utilized without having to pay any fees. If you buy deep-in-the-money puts, you are effectively shorting the stock because there will be little if any premium on puts that are deep in the money.
Before I hit some examples, however, I want to mention the only types of stocks I’ll consider this strategy for.
- Stocks that are clearly headed for bankruptcy: It might take awhile to get there, but these are companies who do not have a sustainable business model. Their days are numbered, but enough people are holding out hope that it gives the stock more value than it should have.
- Stocks that are insanely overvalued: One must proceed with caution here, because if it’s insanely overvalued, that doesn’t mean it can’t go higher. Momentum stocks can burn you. The criterion here is that the stock is trading at far higher multiples in relation to even the craziest possibilities for growth.
- Stocks in what have become “sunset industries”: These will take awhile to develop and pay off, but they will. Newspaper stock McClatchy (MCI) is a perfect example.
So here are some examples of shorts where I can’t find shares to borrow, but I can buy puts.
Groupon (GRPN) has cratered since its IPO. It once sat at $26; now it’s at seven bucks. It trades at a P/E of 41, yet I see only 10% revenue growth going forward. I don’t think the company has a sustainable business model. It’s easy to replicate and has been. It has direct, focused competitors like LivingSocial, and Google (GOOG) and Amazon (AMZN) have gotten into the game. I think Groupon will go under, but I can’t short the stock. In this case, you don’t want to pay a premium when the stock is so close to zero. So, buy the January 2014 17 put for $10. Now you are effectively short the stock, and still able to exit by selling it for either a profit or loss anytime between now and expiration.
Life Partner Holdings (LPHI) was once the leader in life settlement contracts. This is a transaction where someone sells their life insurance value at a discount to collect money in the here and now. The buyer basically hopes the seller will die in a time frame such that they receive a good return on their investment. However, the company is under investigation and shareholder lawsuits. LPHI trades at $3, and management keeps pumping out massive dividends it can’t afford. I can’t find shares to short, but the October 7.50 put is going for $4.50.
I don’t believe SodaStream (SODA) has a sustainable model. I just don’t think people will use the product over the convenience and cheaper alternative of just buying soda at the store. The stock trades at 28 times earnings and has no free cash flow. It trades at $70 and I can’t find shares to short, but I can buy the October 95 Puts for $27.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.