Last Friday, Chicago-based Groupon (GRPN) announced that it had underestimated the percentage of returns on its higher-valued deals. As such, the company offered a bleaker forecast for its first-quarter numbers and lowered its fourth-quarter numbers from last year. Groupon admitted its mistakes and assured investors that the issue has been resolved, that this will be a one-time occurrence, and that the future looks as bright as ever moving forward.
On the trading floor, we have an old saying that goes, “there is never just one cockroach.” So, what do the markets think of Groupon?
For starters, it was down more than three dollars per share, or over 16 percent on Monday. Furthermore, the stock remains “hard to borrow”, meaning that you would find it extremely difficult, if not impossible to try to sell the stock short. This “hard to borrow” phenomenon is common in stocks that lots of market participants are trying to sell short. It’s usually not a badge of honor for the company.
Nevertheless, there are some investors that do want to hold on to their Groupon shares. So, what could someone who wants to hold on to Groupon do? Well, for starters, you can hope that the analysts are wrong and that the stock has bottomed out. Of course, you could always sell your stock. However, if you are a savvy options trader AND you are long the stock, there is one other alternative that you can consider – you can switch out your real Groupon stock for the synthetic equivalent!
Now, before you freak out over the idea, hear me out:
If you are long Groupon stock, you are one of the many fortunate folks that can sell the stock. Furthermore, if you plan on holding the stock for at least another six months, you can take advantage of the current option pricing to receive a fairly decent credit to your account, while maintaining a position that has the same risk as your long stock position.
Here’s how it works:
Step 1: Find out how much stock you want to replace. For the purposes of this example, let’s assume you have 200 shares of Groupon.
Step 2: Place the following trade as a package:
Buy 2 of the October 15-strike calls
Sell 2 of the October 15-strike puts, and
Sell your 200 shares of stock.
That’s it! Now, let’s see what you have accomplished:
Buying the 15-strike call and selling the 15-strike put is what we refer to as being synthetically long stock for $15 per share. So, the question, naturally becomes, “How much did I pay to get long a stock for $15 per share?”
With Groupon trading for $15.28, you don’t want to pay more than 28 cents to place this trade. To be sure, let’s look at an option chain:
This option chain shows the markets in the Weeklys with 4 trading days to expiration (call bid/ask on left, put bid/ask on right), and the October(bottom line) options with about 200 days to expiration.
In the Weeklys, if you buy the 15-strike calls on the ask price for 60 cents and you sell the 15-strike puts on the bid at 35 cents, you have paid a net 25 cents to buy stock for $15 per share. This means that you have effectively paid $15.25 per share to hold GRPN through expiration, which occurs in four days. While this is slightly cheaper than what it costs to buy the real stock according to the last print, it is negligible compared to the possibilities for someone willing to be long GRPN stock through October expiration.
Here, things get a little more interesting. If you buy the October 15-strike call for 2.00 (market shows 1.80 bid and offered at 2.00) and you sell the 15-strike put on the 3.50 bid, you once again end up synthetically buying stock for $15 per share. However, by using the October options, you would receive a $1.50 credit. This means that you would effectively be getting long GRPN for $13.50 per share. This is significantly better than buying the stock in the open market for just over $15 per share.
How does it Settle?
At the end of the day (in October), either the call will be in the money (so that you’ll exercise it and buy the stock), or the put will be in the money (so that you get assigned and buy the stock). Either way, you’d be long GRPN for $15 per share.
As for the “hard-to-borrow” premiums, note that in just about all cases, the premium is reduced as your options approach expiration, so that eventually, the synthetic prices and the real stock price should line up.
I hope you’ve enjoyed taking a slightly different look at how option pricing may help some people gain a different perspective on certain stocks.