Friday, May 20, 2011

So why can't you short LinkedIn?

A contributor at notes that he can't buy put options on LNKD, nor can he short it.  This really shouldn't come as much of a surprise.  

Finance professors often argue that prices should accurately reflect all public information and should be unbiased measures of the true fundamental value.  But they will add one important caveat - and that is that there are limits to arbitrage.   In the case of LNKD, which by any reasonable measure is ridiculously overvalued, an obvious strategy would be to short sell the stock or to buy put options.   But as with most overvalued IPOs neither option (excuse the pun) is available.  

First of all, to short the stock you would need to find someone to borrow the stock from.  Most of the current holders of the stock have no interest in lending their shares to someone who is going to bet on the price going down.  And even if you could borrow the stock, the lending cost would be astronomical.  Case in point: I vaguely remember the annual borrowing cost for Krispy Kreme stock (an overvalued donut maker) being 50%+ per year.   This means that the stock would have to fall by 50% just for your short position to break even.   Suffice to say, shorting LNKD is unlikely to be feasible.   

Buying put options is also unlikely to be a possibility.  This is because option writers (those selling puts) are not stupid.   If you write a put you expose yourself to losses if the price of the underlying stock falls, and as a result most put writers will offset this risk by simultaneously shorting the stock.  Again we're back to the problem that you can't find anyone to lend you shares. 

I'm sure that LNKD will eventually fall back to earth, that is, unless MSFT buys it.