A lockup is a contract that a company has with its founders, investors and employees. It prevents them from selling any shares after an IPO, usually for a 180-day period. So at expiration, it is typical to see a spike in selling, which can drive down the stock — just as has happened withf Facebook (NASDAQ:FB), Groupon (NASDAQ:GRPN) and LinkedIn (NYSE:LNKD).
Yet the lockup phenomenon is far from fool-proof. Just take a look at Yelp (NYSE:YELP). Yesterday it’s lockup expired and the stock surged by 22.5%!
How could something like this happen? It’s important to keep some things in mind. First, for example, a lockup expiration does not necessarily mean that the insiders will dump their shares. Simply put, some managements have fairly tight control over their organizations — as seems to be the case with Yelp. In yesterday’s trading, the stock saw volume of 8.6 million shares, while52.7 million shares were freely tradable because of the lockup expiration.
Interestingly enough, another issue could be a short squeeze. This is when there is a large percentage of the stock that is shorted — say over 20% — and the short sellers cover their positions en masse. This adds even more demand, which often spikes the stock. As for Yelp, the short interest was a hefty 41%.
Keep in mind that the short squeeze often happens because the short sellers have already made a bundle. And yes, this appears to be the situation with Yelp. A couple weeks before the lockup, the stock dropped about 30%. In other words, investors had already discounted the impact of the lockup expiration.
For the most part, I think shorting the lockup period is generally a bad idea anyway. It’s extremely difficult to get a sense of how many shares will hit the market, and it may just be a trickle in the short run.
Instead, the lockup is often a good entry point for a stock. That is, if you already like the company, then wait until the shares begin to come onto the market, because it can be a good way to get a much better bargain.
Tom Taulli runs the InvestorPlace blog IPOPlaybook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli. As of this writing, he did not own a position in any of the aforementioned securities.