Can I Borrow Some SNAP?

by CC June 8, 2017 3:25 pm • FREE ACCESS

We’ve fielded a few questions lately on SNAP stock. One, in particular, yesterday was looking to position for downside looking out to August but was a little shocked at the price of puts. We wanted to go over a couple of factors currently affecting options prices in SNAP and what that says about overall positioning in the stock.

The first thing to look at is what the market currently expects as far as movement in SNAP. The company is expected to report its second quarterly earnings as a public company during August expiration. Right now, the options market is implying about a $4.80 move in either direction between now and August expiration, or about 25% (which is a tad more than the 21.5% one day drop the stock suffered following its Q1 report). To put that in perspective, Facebook (FB) is only expected to move about 7% in either direction and Twitter (TWTR) about 11% between now and August expiration. And that makes sense as there’s so much we don’t know about SNAP at the moment, and we’re likely to find out in August.

But there’s another factor at work here and that’s the massive levels of short interest in SNAP at the moment. From Bloomberg today:

Snap Inc. is the most-shorted tech initial public offering of the year, with a growing number of traders betting the stock will fall.

Investors are skeptical that the company, which owns the Snapchat photo-sharing app, can grow quickly enough to justify its valuation — now at about $22 billion — given aggressive competition from Facebook Inc., which has been copying some of Snapchat’s features. That’s helped drive short interest in Snap up to 28 percent of the free float, or shares available to be traded publicly, according to data from Markit Group Ltd. The increase comes before the first lockup expiration on the shares — on July 30 — when certain stakeholders and executives will be free to unload their positions for the first time since the March 1 IPO.

For comparison, FB’s short interest is around 1% of the float, and TWTR, another heavily shorted stock is about 9%. So SNAP’s 28% is pretty big. So this is where we see the second effect of all those shorts. SNAP is pretty hard to borrow right now and it’s showing up in the options market.

Looking at July expiration, vs 18.85 in the stock, SNAP’s 19 calls are 0.90 and its 19 puts are 1.65. With the stock 18.85, the 19 puts should be trading more than the calls, but by about 25c… not by 90c. (Compare that to TWTR at 17.50, the July 17 calls are 1.15 and the 17 puts .60, for a difference of 55c about in line with where the stock is trading).

In a nutshell, if you wanted to short SNAP stock synthetically, by buying a put, and selling a call of the same strike, it would cost you about .60 on a lower entry in the stock. Under normal conditions that should be right around where the stock is trading. The reason for that? Because it’s hard to borrow shares to short in the equity market. And therefore, a lot of it is being done in the options market.

And from an options market maker perspective, when someone buys puts from you, you sell stock to stay delta neutral. But if there’s risk of you being bought in on your short shares due to it being hard to borrow, you need to get paid for that risk. That extra .60 on the synthetic stock is the risk premium for options market makers to sell those puts.

And is what we’re seeing in the equity market of massive levels of short interest translating directly into the options market? The answer is yes, from Bloomberg:

The top nine most-owned options are all puts — or contracts that can be exercised if the stock falls below the exercise price.

The January 2018 $15 put options, with an exercise price 23 percent below Wednesday’s $19.56 close, had the highest open interest, which is the number of contracts outstanding, according to data compiled by Bloomberg.

So any outright put positions in SNAP need to take this into account. You are paying up for the right to own a put, because the person selling it has risk to hedge in the stock, because so many are already short the stock.