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Stocks can struggle after initial public offers as insiders sell shares and pressure the price of the stock. That recently happened with an IPO that fell as soon as insiders could begin selling.
CNBC reported in early March that, “Elastic shares dropped 3.5 percent Wednesday after the software company’s initial post-IPO lock-up period expired, allowing insiders to sell stock for the first time.
Elastic, which provides open-source search software used by businesses, went public in October at $36 a share and the stock has since surged, closing on Tuesday at $87.14.
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Last week the company said that 25 percent of the shares that have been subject to lock-up agreements will be released and available for sale, so long as the stock’s closing price on Monday was at least 33 percent higher than the IPO price.
In its IPO prospectus, Elastic said the lock-up period would cover the traditional 180 days after the offering, which would be early April. But conditions were met to accelerate the process.
On Wednesday, trading volume topped 2.3 million shares, making it the most active day for Elastic since its debut on Oct. 5. For the third consecutive day the stock moved more than 3 percent lower.
Lock-up expirations have hit other technology companies in recent years, including Nutanix, Pivotal and Roku, introducing sudden dips and spikes in trading volume.
Elastic has been lightly traded to date, because only 29 percent of the shares outstanding were available to be traded, with the rest owned by insiders, primarily early employees and venture investors.”
Operational Concerns Also Weigh on the Stock
There are also concerns about the company’s operations, as CNBC recently reported,
“Open-source search software company Elastic saw its stock fall as much as 5 percent [recently] after Amazon Web Services announced the launch of a separate library of open-source code for Elasticsearch, a set of technologies that can be used to build search engines for web sites, and an important part of Elastic’s business.
The move shows Amazon acting with a higher level of platform power as the world’s businesses, schools and governments become more reliant on cloud providers, which now deliver basic computing and storage tools as well as higher-level services.
As AWS is ahead of every other cloud provider, including Microsoft and Google, its moves in the open-source world can have an outsized impact on the companies that focus on distributing it.
According to reports, “Amazon and Elastic are tangled in a complicated dance of cooperation and competition, as is often the case with open-source technologies, which are free for anybody to modify, use and share.
AWS has its own cloud service that draws on the Elasticsearch open-source technology. It competes with Elastic’s own cloud-based service, which is available on AWS.
AWS executive Adrian Cockcroft … wrote that AWS decided to act because it felt that Elastic’s own repository of Elasticsearch code has become a blurry mixture of some code that has an open-source license, and some proprietary code.
“We have discussed our concerns with Elastic, the maintainers of Elasticsearch, including offering to dedicate significant resources to help support a community-driven, non-intermingled version of Elasticsearch. They have made it clear that they intend to continue on their current path,” Cockcroft wrote.
He noted that Expedia and Netflix, both large AWS customers, will be involved in the new community.
On Tuesday Elastic CEO Shay Banon shot back with a blog post of his own.
“Our products were forked, redistributed and rebundled so many times I lost count,” Banon wrote. “It is a sign of success and the reach our products have. From various vendors, to large Chinese entities, to now, Amazon.
There was always a ‘reason,’ at times masked with fake altruism or benevolence. None of these have lasted. They were built to serve their own needs, drive confusion, and splinter the community.”
This could be a chance to consider taking profits on the stock for shareholders or for traders to use bearish strategies.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in ESTC
For ESTC, we could sell an April 18 $80 call for about $4.40 and buy an April 18 $85 call for about $2.02. This trade generates a credit of $2.38, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $238. The credit received when the trade is opened, $238 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $262. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($238).
This trade offers a potential return of about 90% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if ESTC is below $80 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $262 for this trade in ESTC.