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This Famed Short Seller Targets a Recent IPO

This Famed Short Seller Targets a Recent IPO

Initial public offerings (IPOs) are in the news recently and there is almost always a sense of excitement when trading begins. But one famed short seller advises taking a more cautious approach to one recent offering.

CNBC reported, that Citron Research chief and noted short seller Andrew Left says he’s short Beyond Meat (Nasdaq: BYND). The company, he notes, “has become Beyond Stupid.”

BYND comment

Left, known for betting against Tesla and Valeant Pharmaceuticals, confirmed in an email to CNBC that he took a short position in Beyond Meat Friday. Beyond shares were down 6% in afternoon trading.

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He added that its stock performance “seems to be all retail-driven without any fundamental basis.”

Notwithstanding Left’s prediction for a 25% plunge in Beyond’s stock price, the El Segundo, California company remains a bright spot in a string of shaky starts for 2019 IPOs.

Beyond’s products, including fake ground beef to burgers, are designed to replicate the consistency and taste of meat. Instead of animal protein, the meat alternatives use gluten- and soy-free products from peas and faba beans. And with more Americans experimenting with flexitarian diets, demand for Beyond Meat shares surged during its initial public offering earlier this month.

In one of the strongest kickoffs this year, shares rocketed 163% on May 2, the first day of trading for the equity. Beyond Meat, which priced its initial public offering at $25 per share, has seen its stock rally to highs north of $90 by Thursday’s close.

But Beyond’s rapid ascent — and popularity among retail traders — has Citron’s Left convinced its price tag has grown frothy, especially with competitors like Impossible Foods eyeing the public market. Despite a market capitalization north of $5 billion, Beyond only generated $87.9 million in 2018.”

The stock has a short trading history and the volatility can be seen in the chart below. Left contends that the price action is largely divorced from the underlying fundamentals of the company and the price can not be justified based on financials.

BYND chart

There is a risk to the trade in that the stock may be ahead of the fundamentals which makes it speculative. Speculative frenzies in stocks can persist for some time and prices can remain at what some consider to be irrational levels for an extended period of time.

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 anard.

bear call spread

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 BYND

For BYND, we could sell a June 21 $87.50 call for about $8.50 and buy a June 21 $90 call for about $7.30. This trade generates a credit of $1.20, 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 $120. The credit received when the trade is opened, $120 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $130. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($120).

This trade offers a potential return of about 92% 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 BYND is below $87.50 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 $130 for this trade in BYND.