Why Snap Inc (SNAP) Stock Could Soon Rally

Here's why the Snap stock short selling could be setting up a rally

     

Even though it’s only been two weeks since the public offering of Snap Inc (NYSE:SNAP), there has already been plenty of gut-wrenching volatility. After a 44% pop on its first day of trading, Snap Inc shares quickly trailed off. Note that Snap stock is about 29% off its high.

Why Snap Inc (SNAP) Stock Could Soon Rally
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Yet this should not be surprising. Let’s face it, whenever you make a bet on a new-fangled technology, you should expect a roller coaster ride.

A spot-on case study of this is Facebook Inc (NASDAQ:FB). After its debut in May 2012, the stock price would go on to tumble by about 50% in three months. But, of course, selling into this would have turned out to be a big mistake.

Getting Technical With Snap Stock

When it comes to IPO investing, it’s important to keep in mind that the swings in valuations are not just about fundamentals. In fact, the technical factors can have even more of an impact. The reason is that a new issue is getting seasoned in the market.

Actually, a key part of this process is short selling. To see how, let’s take an example: Suppose John buys 100 shares of Snap stock through his margin account at Charles Schwab Corp (NYSE:SCHW). By doing this, he has allowed the brokerage firm to lend these shares to short sellers.

Next, you want to short 100 shares of Snap stock since you think the valuation is crazy and believe the price will continue to fall. You do this through your Schwab account by borrowing the stock and then selling it on the market. This means you are required to — in the future — buy back the 100 shares to close out the trade.

If this is at a lower price, then you will have made a profit. Essentially, when shorting, you are selling first and buying later. Now let’s say that when you sold your 100 shares, the buyer happened to be named Jane.

So notice something? Well, John owns 100 shares and so does Jane. In other words, 100 shares have been created!  Yes, short selling actually increases the float of a company’s shares.

Thus, for a new issue like Snap stock, this can mean lots of pressure in the early phases. This is due not just to the actual sales by the short sellers, but all the extra stock that is dumped on the market. It’s essentially a double whammy.

But all this is really a short-term thing. After all, the initial issuance of stock of an IPO is generally small. For instance, in the case of the SNAP IPO, the company sold 200 million shares — and 50 million were subject to a lock-up (for one year).

Yet there is something to keep in mind …

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