There are a number of reasons for a private company to offer its stock for sale to the public by means of an IPO or Initial Public Offering. The two main reasons seem to be a need by smaller companies to raise capital for expansion or larger privately owned companies that seek the status of being listed on an equities exchange, where their stock becomes publicly traded, accompanied by the publicity surrounding an IPO. In many cases, once a company has made an IPO, these stocks are then available to trade on many binary options trading platforms.
The IPO Process
The IPO process starts with the company obtaining the services of an underwriting firm who will typically advise on the type of security that should be issued, whether the offer should be for common stock or preferred stock, the optimum price at which the stock should be offered as well as the timing for its opening on the market.
Very often, a portion of the stock being offered in the IPO is placed privately shortly before the IPO date of entering in to the market. Such a private offering usually involves the sale of stock to equity or hedge funds and would generally be at a lower price than the IPO because such investments are usually pretty large. The discounted price would also typically include a lock-up period during which the purchaser would not be able to sell the stock. Companies generally view stock sold in this fashion to represent a long term investment by the fund purchasing the stock.
The offer price is determined a few days before the IPO by the underwriter in consultation with banks and brokerage houses who are able to ascertain the expected demand for the stock from their clients who have expressed an interest in purchasing shares. The offer price will often be the price paid by institutional investors who have agreed to purchase the stock a few days before the IPO. Individual investors buying the stock after the IPO would usually have to pay a premium for the stock as the market generally opens higher than the IPO on the first day the stock is traded.
Private Investor and the IPO
An IPO would typically generate a large amount of hype for its debut day on the market with a lot of media and investor attention focused on the company and the stock market in question. There are several fundamental questions about an IPO that should be considered by investors before getting caught in the excitement of the occasion.
An IPO company does not have a history or a track record that can be used as basis for any investment decisions. The IPO itself is an offer to sell stock and is at the same time designed to entice investors to purchase the stock and should always be viewed with a degree of cynicism. Important factors that can be checked are the quality of the management team as well as the intended use of the capital raised from the IPO. These facts very often give pointers as to where the price of the stock is headed. The standing of the underwriter should also be taken into account as a successful and larger underwriter will generally not involve itself with a questionable IPO, while smaller investment banks might well be tempted to underwrite a risky IPO.
On the upside, many binary options brokers, such as Option.FM, usually provide detailed information on a company’s IPO which enables traders be informed before they trade. In binary options trading, a trader does not actually purchase the asset but merely makes a prediction of the direction that the price will move. Collecting as much information from your broker will help you to trade more accurately.
The Day After
Stocks will generally close at a premium to the IPO price after the first day of trading and unscrupulous investors, who acquired stock before the IPO, can be tempted to offer the stock within a few days of opening. This practice, which is called flipping, is discouraged by brokerages and reputable investment houses alike, but it does happen as investors decide to take a profit by disposing of the stock. Remember to keep this in mind when you make your trade on the Option.FM trading platform. Stock prices fluctuate all the time but if there is an indication that the price will rise on the first day of the IPO, this might be a good opportunity to make a Call option trade.
Flipping is the very reason why reputable underwriters would rather offer pre IPO stock to equity and other large investors who look for long term investments and are happy to have a lock-up period, rather than looking to make a quick buck. You will notice that many IPOs that have big opening days come back to earth very quickly and for this reason it’s not advisable to buy stocks of an IPO if you are a small investor.
Importance of the Lock-up Period
We discussed the importance of the lock-up period earlier in this article, where the company doing the IPO looks for long term investors who can add value to company with further investment or injections of capital. Investors do sometimes become disenchanted with investments that they have made and will try to offload the stock as soon as the lock-up period ends, which may result in the stock dropping substantially in price. The result might create a buying opportunity for smaller investors at a lower price, as well as a great investment opportunity for binary options traders to make Put option trades.
It is for this reason that some investors recommend that you stay away from an IPO during the first few months, unless you have been fortunate enough to buy at the IPO price. Professional analysts at Option.fm take the view that news of hedge fund or equity investor stock sales creates fertile ground for binary options traders as prices seem to follow a directional trend quite strongly.
Remain Level Headed
Underwriters are professional salesmen and their function is to create as much publicity as possible for the IPO to ensure that investors are queuing up to buy the stock which pushes the price up and results in a successful IPO for the underwriter. Don’t rush out to buy the stock because it’s an IPO and the underwriter says it a great investment. Check the stock out and if it looks to be a good investment then that should be the only reason to trade.