Shorting Beyond Meat? Be Careful...

Want to Short Beyond Meat (BYND)?

Be careful, it’s more expensive than you might think, whether you sell the shares or buy puts.

Beyond Meat is booming, up 300% since its recent IPO.

Though strong investor demand for shares in the booming plant-based protein industry is certainly part of the reason for the incredible rally, a more likely cause is specific market mechanics regarding short sales.

The options markets give us some insight into the main reason for the unprecedented rally and rapid price movement in the stock recently.

First we have to revisit the concept of call-put parity.

There’s also a more thorough discussion of the concept here>>

You’ll recall that the price of a call, minus the price of a put with the same strike and expiration date, plus the strike price must equal the future price of the stock. The future price is defined as the current price plus the cost of carrying the stock to expiration, minus any dividends paid during that period.

The equation assumes that we can borrow money (to buy stock) or lend money (to earn interest on the proceeds of stock sold short) at a single interest rate, which is not exactly true, but it’s close enough for this example.

C – P + K = F

If the market prices violate call-put parity, a trader could buy the call, sell the put and sell the stock, (or do the opposite of all three trades if the mispricing is in the opposite direction), then simply hold all three positions to expiration and lock in a risk-free profit.

Because of the obvious appeal of arbitrage profits, mispricings like this happen very rarely and don’t last long.

Let’s take a look at a deep, liquid stock like Microsoft (MSFT) and the market prices of relevant options just before the close of trading on Thursday:

Stock price: 127.35

Options:

Bid Ask

JAN 125 Call $10.85 $10.95

JAN 125 Put $7.90 $8.00

Using the midpoints of the option bid-ask spread and plugging them into the call-put parity equation, we get:

10.90-7.95 + 125 = future price

127.95 = future price

That would imply a time premium of $0.60 on top of the current stock price to arrive at the future price, which implies an interest rate of 1.9% annually – a thoroughly reasonable number given where short term interest rates currently are.

Since MSFT will pay $0.92 in dividends before the options expire:

Microsoft stock price * (days to expiration/days in year) * interest rate – dividends = cost of carry.

127.35 * (225/365) * 0.019 – 0.92 = 0.60

So in the case of MSFT, arbitrage free call-put pricing is evident, just as we would expect.

Now let’s take a look at BYND option prices today.

Stock price: $99.85

Options:

Bid Ask

JAN 95 Call $16.20 $16.90

JAN 95 Put $35.10 $35.80

BYND does not pay dividends, so we can leave that part out.

Again using the midpoints of the option bid-ask spread and plugging them into the call-put parity equation, we get:

16.55 – 35.45 + 95 = future price

$76.10 = future price

In this case, the futures premium seems to be negative $23.75. Assuming an interest rate of 1.9%, a trader could buy the call, sell the put, sell the stock and collect $23.75, then simply wait for expiration to buy the stock at $95 and keep the $23.75 (plus $0.27 in interest) as risk free profit, right?

Wrong.

In illiquid stocks that have a high percentage of short interest, clearing firms and prime brokers often charge customers on a percentage basis to find shares that can be borrowed and sold short. In the case of Beyond Meat, that percentage is now between 75% and 100% annually.

With relatively few shares outstanding and huge demand in short selling this high flying and – by many measures – massively overvalued stock, there are almost no shares available to borrow and sell.

Those who are short BYND have to find a price at which someone who already owns the stock wants to part with it. Those who are lucky enough to be long can simply sit on their hands and wait for higher prices, safe in the knowledge that the market is full of desperate buyers and a relative scarcity of sellers - because initiating a new short position is difficult if not impossible.

It will likely take some time for the markets to sort out the inefficiencies and BYND will remain volatile until that happens. Eventually, those with losses will cover their positions and lick their wounds and those with profits will find it irresistible not to lock them in and will close up and go on vacation. When that finally happens however is anyone’s guess.

Trading Application

The above was mostly an explanation of what’s happening in BYND stock and options rather than specific trading ideas, but it does present an important insight into trading stocks that become hard to borrow during a short squeeze.

Let’s say that for whatever reason, you want to buy BYND stock right now. Maybe you’ve decided that it’s going up from here and want to be long (be careful) or you’re already short the stock and want the pain to end (sorry), buying shares in the open market is a terrible idea. Because of the negative premium on the future price that we described above, you can buy it much cheaper using options.

If you buy the JAN 95 call for $16.55 and sell the JAN 95 put at $35.45, when the options expire, you will definitely buy the stock for $95/share. Either the call you own will be in the money and you’ll exercise it, or the put you’re short will be in the money and it will be assigned to you, but either way, you’re buying shares for $95, but minus the $18.90 you collected on the options spread. Your net price will be $76.10

Keep in mind that if you were to open a long position in this manner, you wouldn’t be able to close it and keep that $18.90 until after expiration. If you’re closing a short position, it’s a no-brainer.

Even many professional traders don’t understand this concept. Certainly anyone who’s covering a short position in the open market is giving away cash. Especially when things get weird, there’s often a way to use options to make better trades.

It also means that buying those 95 puts is not a cheap or easy way to get short. Because of the negative interest rate, the stock would have to decline 35% before you see the first cent of profit.

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