IPO's can have an exciting impact on ones portfolio. Not only that, they are fun to research, and the possibilities are almost limitless. In addition, the IPO markets have been waking up lately, giving investors plentiful choices in different types of companies, in different sectors, and of all different sizes. Some of the smaller IPO's have been quietly trending higher, while the big, media focused IPO's have been steadily attracting more and more attention. With all this potential, we thought today we would look at how limited you really are when investing in this arena.
Direction: Simply put, the only choice you have is to be a buyer. When a new company comes to market the only sellers that are usually allowed is the company itself. Even the insiders can't usually sell on the open market. There is typically a lock up period that they agree to when they subscribe to shares "pre-IPO". So, as a new, public investor your only choice is to buy.
For those that may have a negative view of an IPO, or feel that it is over valued, all you can do is sit back and watch to see if your assumption is correct. There is no shorting allowed.
Options: Options are more popular than ever, and at the very least investors have been looking to sell covered calls on their positions or on their portfolio as a whole. Well, with IPO's there will be no options to choose from. Usually, if there is even going to be an option market, that will come later once the stock has settled. A portion of option pricing models is based on historical volatility. With the lack of history, it is impossible to create an efficient option market on the first day of a new issue.
With these limitations you can see why many feel that investing in IPO's is risky. With the limited knowledge of the company, along with only one choice for the public investor (long), keeping a position small, and doing your homework become exponentially more important.