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(Options) Part 1: The Simple Basics of Stock Options Trading - Trading with the Trends - IPOs

IPOs are the simple basics of stock options trading and a part of the market that always generates a great deal of interest, along with stories of fabulous profits and spectacular losses. But, there are a ways to reliably profit on IPOs. Look for the trends that they cause and trade with them. IPO spinoffs are a solid basics of stock options trading trends to work with. A company that's going to spin off a part of itself as an IPO tends to move steadily up in price until the IPO date, starting a week or two before ... read more

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IPOs are the simple basics of stock options trading and a part of the market 
that always generates a great deal of interest, along with stories of fabulous 
profits and spectacular losses. But, there are a ways to reliably profit on 
IPOs. Look for the trends that they cause and trade with them.
IPO spinoffs are a solid basics of stock options trading trends to work with. 
A company that's going to spin off a part of itself as an IPO tends to move 
steadily up in price until the IPO date, starting a week or two before that 
date. On the day the IPO starts to trade, the parent company's stock options 
typically dips sharply. The best strategy is to buy the parent once it starts 
moving in anticipation of the spinoff, sell it the day before the IPO is to 
begin trading, and then short the parent just after the IPO starts to trade.
Another basics of stock options trading trend to consider is the 'quiet 
period' trend. The 'quiet period' for IPOs is the twenty-five days after a 
company goes public. During this time, the SEC forbids the company and the IPO's 
underwriters to say anything that isn't covered in the company's prospectus or 
final registration statement. The underwriters face further restrictions on 
issuing any research.
Another basics of stock options trading tip is that as stocks near the ends 
of their quiet periods, they tend to steadily rise in price in anticipation of 
the 'strong buy' recommendations most will receive from their underwriters after 
the quiet period ends. The run-up usually begins about ten days prior to the 
quiet period expiration, and is often accompanied by steadily increasing volume. 
It's wise to sell quiet period stocks the day before the recommendations come 
out. Why not hold the stock options after it gets a 'strong buy' recommendation? 
It's another case of buy the rumor, sell the news. It's also best to trade this 
trend with stocks that have highly respected underwriters and are in hot 
sectors.
Another basics of stock options trading play is to short stocks with upcoming 
IPO lockup expirations. An IPO lockup is a period of time, usually from six to 
eighteen months, when insiders who obtained the IPO at the offering price or 
less cannot sell their shares. Once this time period has elapsed, insiders often 
sell their shares. This trend is shortable because the greater the number of 
shares unlocked, the more likely it is that insiders will start to sell their 
shares, particularly if the market is not doing well but the share price is 
still higher than the IPO offering price. And the more shares freed, the better 
the chance of a negative effect on the share price. This trade works best when 
the number of shares being unlocked is more than 25% of the current market 
capitalization. 
You should short the stock options roughly ten days before the IPO lockup 
expiration date, since anticipation of the event usually scares traders out of 
the stock options well before its actual date. Cover the short about five days 
after the expiration date. By that time, most insiders will seem to have sold, 
and the news will be priced into the stock options.
Like any other trade, these basics of stock options trading tips are not 
foolproof. Often one of the underwriters will upgrade the stock options as the 
lockup expiration approaches, or the company will release news to boost the 
stock options price to counter-act the selling. Be sure to check company news 
closely, since if the market is bad and share prices are down, lockup periods 
may be extended.
But when the IPO market is hot, a lot of traders buy into any new company. 
They commit a trading mistake that's like placing an overnight market order: 
They place market orders for an IPO before it starts trading on its first day, 
which leads to outrageous run-ups in price right when trading opens. For the 
trader, these orders are a sure way to lose money. Your order will end up being 
filled at a ridiculously high price that the stock options may never see 
again.
If you're going to try to trade an IPO on its first day, don't place a pre 
opening market order. Don't use market orders at all. The way to buy is with a 
limit order after the stock's price has pulled back a bit and is about to bounce 
and continue upward again. The goal is to buy at the bottom of the bounce, hold 
it as the price rises, and sell just as the price is about to fall again. You 
may be able to do this several times, until the stock's momentum drops. 
Remember, you can't short an IPO during its first thirty days on the market.
If you want to hold the IPO past its first day, it's hard to know exactly 
when to jump in, but wait until after the initial volatility has ended. The 
higher the IPO has opened the less chance it has of continuing to climb 
throughout the rest of the day. If the IPO has opened at an extremely high 
price, it will probably sink to a fairly stable level in an hour or two. If not, 
and you think the price could go higher, you might want to buy fairly soon after 
the initial volatility has ended. One option is to buy half your shares and then 
wait to see whether there's a slump in the price later in the afternoon when you 
can buy the rest for less. IPOs can be incredibly volatile, and like with any 
other trade, setting stops is critical. But, traded carefully, these basics of 
stock options trading tips are a consistent way to create trading profits.

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