Learn what an IPO lockup period is, how it can impact the stock market, and what IPO trading strategies investors and company insiders should consider.
After an initial public offerings (IPO) goes public and trades on the open market, it can sometimes experience a drop in stock price as the lockup period ends, so it’s important for investors to understand what a lockup period is, how it affects stocks, and possible ways to navigate it as an investor.
Some companies compensate their teams with large stock awards, but they don’t want employees to sell large amounts of stock as soon as the company starts trading, so they implement a “lockup” period to prevent employees and other insiders, people close to the business, from selling their stock when the company goes public. Typically, lockup periods last between 90 and 180 days.
Lockup periods are important for investors to monitor because the supply of stock available in the public market (known as the float) can increase significantly once insiders begin selling. Unless an accompanying increase in demand meets this new supply, the stock price could potentially fall, at least in the near term. In most cases, the lockup period is public knowledge, so investors know when the lockup period is coming to an end. As a result, stock prices might be influenced by the approaching lockup period expiration date. In some cases, the approaching lockup expiration results in some investors exiting their positions in an attempt to capture gains before the new selling ensues as insiders attempt to profit from their shares.
It’s important to note that not all lockup terms are the same. For example, companies can lift lockup restrictions on shares early and announce additional shares not long after its IPO. Investors should always consider the potential for the lockup period and restrictions to change.
Before investing in an IPO, it can make sense to review the IPO prospectus to understand the terms and prepare for potential volatility if there’s a lockup period.
IPOs were once available mainly to institutional investors, but today, some retail investors have access to invest in newly public companies. Many investors choose to invest in IPOs because of potential early gains, although those gains are certainly not a guarantee.
The IPO lockup period, like IPOs themselves, comes with potential risks and might not be for everyone. Even for IPOs that have early success, the lockup period is a risk that most investors face when they dive into a newly public company.
Before investing in an IPO, investors should consider learning some IPO basics that can help them avoid potential IPO investing pitfalls.
Some investors can make the mistake of associating a product with the stock and can invest emotionally as opposed to approaching the investment objectively. When it comes to IPOs, investors should consider keeping a cautious outlook.
Option-approved traders trying to navigate IPO lockup periods might consider the following strategies if the strategies align with their trading objective and risk tolerance. However, keep in mind, there is no guarantee that options will be available during the lockup period, or ever.
Strategy #1: Long put options
Long put options aren’t just for bearish traders. A protective put option can potentially provide IPO investors with a way to profit from a short-term dip or temporarily help manage the loss from a drop in the stock price, even if the investor is bullish on the company overall.
Strategy #2: Options collar
In addition to the stock an investor is seeking to protect, a collar consists of two options from the same expiration period: a long out-of-the-money (OTM) put and a short OTM call. An options collar is an attempt to allow the premium collected by selling the call to help pay for the cost of the put option.
Just as the put potentially limits risk should the stock price drop below the put strike, the short call might cap the potential profit on the stock. Think of the put as a “floor” beneath the stock and the call as the “ceiling.” Where a trader chooses to put the floor and ceiling determines the limitations on the overall risk/return of their position. The short call indicates a stock could be called away at any time until expiration. So, for traders interested in continuing to hold their stock into the future, the risk of seeing the stock being “called away” must be considered.
Strategy #3: Stop order
A stop order allows an investor to potentially limit losses by selling a position if it drops to a certain price. This strategy might appeal to an investor who believes demand will be strong in the first days of an IPO. However, if the investor is incorrect and the stock price declines rapidly, a stop order can serve as a potential backstop. Entering a stop order does not guarantee execution at or near the trigger price, however. Once activated, the order competes with other incoming market orders.
Strategy #4: Wait and move slowly
Consider finding out how many shares will be unlocked at the end of the lockup period. In some cases, the lockup period has a limited impact on the stock because the number of shares being released is relatively low. Investors can find out how many shares will be involved in the lockup period by reviewing the IPO prospectus.
It’s also possible to attempt to manage the risk of large IPO lockup period price movements by purchasing shares in partial increments rather than buying the target number of shares all at once. The idea is to buy the shares at an array of prices during and after the lockup period. Of course, if the price goes up after the lockup period ends, the investor will be buying in at those lighter prices.