After rocketing up 44% on its first day of trading and another 10% on Friday, this hot social media app loved by Millenials is now worth over $30 billion. By every metric that’s stretched, so that’s why we’re recommending this options strategy to short this high-flying stock.
The first big IPO of 2017 and the most anticipated IPO in some time just hit the markets this past week. Of course, I’m referring to the Snap IPO. It’s the first “unicorn” to go public in what seems like forever. If you aren’t familiar with the term, a unicorn is a tech company with a private valuation of over $1 billion. Other famous (current) unicorns include companies like Uber and Spotify.
In the last five years, comparable unicorns to SNAP to go public are Facebook (NASDAQ: FB) and Twitter (NYSE: TWTR). These two companies are also the major comparisons most analysts use when discussing the virtues of investing (or not) in the newly public social media/camera company.
Yes, Snap considers itself a camera company, mostly because management wants to differentiate the company form FB and TWTR. But let’s get real… Snap is a social media company.
If you’ve never used Snapchat before (SNAP’s primary product), it’s a photo-based, instant messaging tool. What really made the product popular when it came out was how the messages/photos would disappear after you viewed them, adding a level of discreetness to your communications with others.
Here’s the deal…
What Snapchat has going for it is its popularity with the 18-35 age group, a highly sought after advertising target market. The app also has 158 million active users. At the time of its IPO, Twitter only had 100 million users (although FB had 483 million when it went public).
While Snapchat’s huge user base means it could have a Facebook-like future, chances are the company is closer to the Twitter business model. Almost four years after going public, TWTR is still struggling to make money or prove it will be able to sustain growth.
There are several other issues with SNAP as well. The user growth has already slowed, and it may have peaked prior to the IPO (like TWTR). The company has also lost half a billion dollars in the year before its IPO – TWTR was only showing a $79 million loss during the same period.
And most importantly, FB’s Instagram is even more popular among SNAP’s target audience and has been taking market share away as new features are being rolled out. In other words, SNAP has a long road ahead to profitability.
The apparent downside though didn’t stop investors from gobbling up initial shares in SNAP – with the company valued at a whopping $33 billion after its first day of trading.
Okay, so here’s the thing…
Options are the best way to make short-term trades, such as the type I would recommend on SNAP (due to the leverage you get). However, options contracts aren’t yet available on SNAP, being a brand new publicly traded stock.
Normally, I’d suggest using a proxy to trade SNAP, such as FB and TWTR, because they will often mirror at least a portion of the move of their primary competitors. However, that wasn’t the case on the day of the SNAP IPO.
Snap’s shares rocketed 44% higher (from the $17 IPO price to $24.48 at close). At the same time, FB dropped about a half percent, while TWTR was unchanged. It’s obviously a very limited sample size, but it doesn’t look like FB or TWTR are going to be closely correlated with SNAP (for now).
So now what?
Fortunately for options traders, SNAP options have been approved to be listed on March 10th, just a few days away. By that time, the initial sheen of the IPO should have worn off, and reality will start to set in.
If you don’t believe SNAP is a $33 billion stock (and I definitely don’t), March 10th or soon after would be a great time to make a bearish trade on the stock using options.
I was not gifted with the ability to predict the future, so there a couple things we don’t know. We don’t know what price SNAP will be trading at on March 10th, and we don’t know how much the options will cost.
However, there are couple educated guesses we can make. First off, SNAP options are likely to be expensive (on a relative basis) because they’ll be in high demand. Second, the SNAP share price isn’t likely to have collapsed yet as new investors will have high expectations for the stock’s ceiling.
That means we should still have the opportunity to make our bearish trade when the options are released. But, because the options probably won’t be cheap, we’ll want to use a put spread (bearish vertical spread) instead of straight puts to reduce the cost of the trade.
I recommend a slightly out-of-the money put spread, with the long part of the spread (buying the put) maybe a dollar or two lower than the at-the-money strike (the same as the current stock price). I’d then set the short part of the trade (selling the farther-out put) about 3 or 4 dollars lower than the long strike. For instance, if SNAP is trading at $25, I’d buy the 20-23 put spread, buying the 23 put, selling the 20 put. In this case, we want to go at least 30 days out, maybe even 60 days in order to give time for the trade to develop.
Keep in mind, we don’t know where the stock price will be so the strategy could alter slightly. You may need to go farther out of the money, or narrower or wider on your put spread. It all depends on how much you want to spend and what your risk level is.
The best part of using options for this bearish SNAP strategy is you can alter the trade according to your own risk level and spending power. You could even make this a bullish call spread if you think SNAP is going higher. While that’s not what I personally believe, options give us the power to craft our beliefs into trades with plenty of flexibility.