Playing IPOs (Initial Public Offerings)

By Larry Potter

When IPOs were a hot item, we were constantly asked, “How do I get in on one?” To be sure, you should know about this type of play because the returns can be tremendous.

In an IPO, shares that can be publicly traded on open exchanges are made available to the buying public. Every corporation has shares, but until the registry and filings are complete they aren't publicly tradeable. Usually a major brokerage firm will "underwrite" or do the homework and background legwork involved with securing shares, i.e. verifying financial records, accounting and promotions, etc. Then the brokerage will set the pricing of the shares coming to market.

Often a hot IPO will price out at, say, 15 dollars per share, but because of the limited amount of shares available and the fervor over them, the stock never opens at the "pricing" price. More times than not that 15-dollar IPO opens at $20 and flies from there.

Let’s say you own 5,000 shares of this IPO. What would it take to get them out of your hands? A higher price right? Certainly! So the price goes up and you sell it to someone else who wants it badly. But again, what will it take to pry it out if his hands? A higher price, of course. So that cycle repeats, often many times in a short time frame, until it reaches a plateau. Then the issue becomes volatile, trading up and down in a tight range.

The stock will finally settle down a bit as the issuing company goes into its "quiet period” when the underwriter is required to stay mum about this new stock for a period of time. After the quiet period is over the brokerage that brought out the IPO usually starts an upgrade campaign and the stock then starts getting more attention and action.

Naturally, everyone would like to have some shares before they are opened, but there are usually few to be had. The company has shares, the underwriters have shares, the market makers have shares, and select customers have shares. Most times the available shares are distributed long before you ever hear about the IPO. If you get lucky enough to get in it was just that, pure luck.

Day traders with the best execution systems can make money on the IPO by jumping in soon after it opens and riding the share price higher. You must be quick to take profits, though, because there can be many swift price swings during that first day.

Another time to trade an IPO is at the end of the “lockup period.”

The lockup rule affects primarily company insiders who control tens of thousands of shares at the low IPO price. They cannot sell their shares for 6-9 months. Until then, their shares are “locked up.”

As the end of the lockup period approaches, the stock often begins a gradual advance as institutions and insiders hype the company in order to maximize their gains. But when shares are no longer locked up, the volume of selling is bound to increase as managers and underwriters bank some cash. Depending on the severity of the selling, a stock can be a short candidate as the lockup period ends.

Any investor looking to buy an IPO after it has started trading should be aware of the lockout date. If the stock has been trading almost six months, it usually means that more stock is coming to market at the end of the lockout period and that could put a damper on the price.

Of course, if the stock is a huge gainer and the company is poised for strong growth, the end of the lockout period may have little or no impact on share price. Investors want those stocks and don't worry about a few more shares coming to market. And there won't be as many shares by sold by insiders if the stock has performed exceptionally well. Like everyone else, many insiders will hang onto the real winners.

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