Monday, September 29, 2014

* GoPro (GPRO) - What "Hard-to-Borrow", "REG SHO" and Visualizations Tell Us About a 260% Stock Rise

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GPRO is trading $87.64, up 6.8% with IV30™ up 7.1%. The Symbol Summary is included below.

Provided by Livevol

The stock has made five consecutive all-time highs.

GPRO stock is ripping, up 180% since IPO, and up 30% in ten days.  On IPO, GPRO priced at $24, and is up 260% since then.

The stock is at an all-time high, the risk as reflected by the option market is exploding, the options are trading at -100% hard to borrow rate (more on that later) and in an attempt to get a borrow it turns out the stock is now REG SHO (more on that later, too).  

In the meantime, the company has just released new products and received an upgrade to $90.  Two very powerful counter-acting forces are working on this stock (upgrades and immense short interest) and the risk is doing what it should... rising... fast.  Buckle up...

Before we get into some of the minutia of hard-to-borrow "stuff,"let's look at some fundamental measures surrounding the firm and some news and some risk and stock charts.

First, a visualization:  GPRO and peers charted with net income % on the x-axis and inventory turnover on the y-axis.

We can see that GPRO has huge inventory turns (generally a good thing) and is in fact profitable... yes... the firm earns a profit... More on both of those measures individually in a sec...

Now let's change direction and turn to risk.  The IV30™  chart is included below.

Provided by Livevol

The implied volatility is the forward looking risk in the equity price as reflected by the option market (IV30™ looks forward exactly 30 calendar days).

In English, the red curve is the risk in future stock price movement.  We can see the red curve exploding of late and nearing an all-time high (which was hit with its first earnings release as public company).  That risk is climbing for several reasons... One of them is the stock movement.

The all-time stock price return chart is included below.

Provided by Livevol

There it is... the linear, straight up equity appreciation.  Who knows what happens tomorrow, but for now, this stock has basically known one direction: up.... a lot.

Now let's look at the news today:
GoPro introduced three new cameras Monday and its stock hit a new high for the fifth straight trading day.

The company unveiled a new top-of-the-line model, the Hero4 Black, which at $499 is $100 more than the Hero3 Black. But the company also introduced an entry-level camera, priced at $129.

Source: IBD via Yahoo! Finance GoPro Hits Another High As New Cameras Introduced , written by Brian Deagon.

Let's turn to some financial measures (which I included in a prior post on GPRO), then examine the REG SHO and hard-to-borrow properties.

Revenue  (TTM)
In the last four quarters total revenue (ttm) grew from $858M to now $1.03B (in the last four quarters).  The firm is trading at ~10x.

Gross Margin %
This is a nice trend, gross margin % has increased from 34.4% to 40.1% over the last year as revenue has been increasing... that's a powerful trend and if it can continue is the sort of combination of operational results that can catapult earnings.

Research & Development over Operating Expenses
GPRO is investing heavily in R&D.  A year ago $0.08 of every dollar in operating expense went to R&D.  As of today, $0.11 per operating expense dollar goes to R&D.  The firm is pushing further into product development and the news today of the new products is the explicit realization of that R&D.

Inventory Turnover
"A ratio showing how many times a company's inventory is sold and replaced over a period.  A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying." - Investopedia.

In this case, it seems that GPRO is showing strong sales... actually very strong sales.

Net Income (Earnings)
The first phenomenon to note is that every bar is positive... GPRO has earnings... We can see the boom and then bust in the last three quarters, but for a company this young and investing so heavily in R&D, the bet for longs is not that net income will improve dramatically in the next quarter or two, but  rather the present value of all expected future free cash flows will grow substantially.

Of course, if that R&D spending from above yields poor results, then it's hard to justify an $11B market cap for a firm that has $35 million in earnings and shrinking.  then again, new products, higher gross margins, growing revenue... that would point to higher earnings.

OK, so the firm is in flux.. it's growing its revenue, its product offerings, its gross margins, its investment in R&D... and its stock price and risk.

So is everyone convinced?... No, not at all...

The stock is now trading REG SHO:

Regulation SHO established "locate" and "close-out" standards that are primarily aimed at preventing the opportunity for unethical traders to engage in naked short selling practices.
Source: Investopeida: Regulation SHO

From the SEC: Key Points About Regulation SHO

English: Market makers (or anyone) can't just short the stock, then go look for a locate (borrow) later.
Now that GPRO is trading REG SHO, it's almost impossible to short anymore unless you have a bank with a lot of people that are long that haven't yet rehypothecated their shares.

More English: You can't get short anymore, it's been borrowed and shorted already.

So what's the impact?... The stock is literally "hard to borrow" (HTB) (i.e. difficult to borrow) and the borrow rate goes from basically zero to now nearly 100% for GPRO.  For those unaccustomed to HTB rates, -100% is very big (but it can go over 100%).

We can see this impact on the options. Put-Call parity holds all the time by the fundamental theorem of finance (which states that if the payoff of one security can be replicated identically by a basket of other securities then that one security and the basket must be priced identically)'  also known as no-arbitrage pricing.

Finally, the Options Tab is included below.

Provided by Livevol

So check this out...

With GPRO trading at $87.64 you would imagine the $87.50 strike calls and puts would be about equal (calls would be $0.14 more).  But... here's what happens when rates go negative:

Calls drop in value and puts rise in value... What would normally be similarly priced options are nowhere near similar.

Calls: ~$4.70
Puts: ~$9.30.

Yep, the puts are worth twice as much as the calls... which indicates... you guessed it... -100% rates (ish).

Using the at-the-money (ATM) straddle we can see that the option market reflects a price range of [$73.50, $101.50] by the end of trading on October 17th.

  • If you believe the stock will be outside that range on expiry or any date before then, then you think the volatility is too low.
  • If you believe that range is too wide, and that the stock will definitively be in that range on expiration, then you think volatility is too high.
  • If you're not sure, and can make an argument for either case, then you think volatility is priced just about right.

This is trade analysis, not a recommendation.

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