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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 68% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

What is an IPO lock-up period and how do you trade it?

The end of a lock-up period is often a key moment for the share price of newly-listed companies. We explain how to trade IPO lock-ups and look at which ones are due to expire in the coming weeks.

Uber Source: Bloomberg

What is an IPO lock-up period?

A lock-up period is designed to stop early investors and insiders from selling their shares for a set period once a company completes an initial public offering (IPO), helping to minimise selling pressure in the early stages of life as a publicly-traded business.

Private companies are typically owned by founders, employees, venture capitalists and private investors. There are two reasons why they take the company public. The first is to raise cash to grow the business. The second is so they can cash-in some of their investment to date.

Newly listed businesses decide how many shares to float, but it is not uncommon for founders or early investors to retain large stakes in the business after the IPO. If one or more of them decided to sell a large amount of their stock then this could seriously depress the share price, which is not in the interests of the company or any of its investors.

Therefore, existing investors are often prevented from selling their shares for set period of time after the IPO has been completed, typically for 90 to 180 days.

Ultimately, lock-up periods are all about providing support to the share price, avoiding volatility and stabilising the market for shares in the initial months after listing.

Subscribe to upcoming IPOs and placings via your share dealing account or share dealing ISA

What happens to a company’s share price after a lock-up period expires?

This means the largest shareholders in the business can only freely sell their shares after the IPO lock-up expiration. A flood of new shares can come onto the market if the owners of those shares decide to sell. If the share price has soared since the IPO, then early investors may want to reap the rewards by selling some of their investments, or if the price has tanked, then they may look to reduce their exposure.

However, it does not mean they will sell either way as they could look to retain shares in the hope of prices heading even higher, or because they believe shares could recover any value lost in the early days as a public company.

A lot of attention is paid to how the share price has performed versus the IPO price, but it is worth remembering that early investors are likely to have paid significantly less. This means many early investors will still be able to book a profit even if the share price has performed poorly after the IPO.

The end of a lock-up period sends a strong signal about the confidence the largest shareholders have in the company’s prospects. If institutional investors decide to dump the stock once the lock-up period ends, then this suggests they have little faith that the company is worth holding. If a relatively small number of shares are sold by these investors, then this shows they want to retain the shares and are bullish on the stock’s prospects.

Typically, if there is a sharp increase in the number of available shares available in a company then this pushes the price of a stock down. It is not unusual to see a stock’s share price fall on the first day that the lock-up shares can be traded. In fact, if other investors (not subject to the lock-up period) begin to sell in the days before the lock-up expires, then this is a sign that they expect the share price to fall.

However, there is also an argument that the end of a lock-up period can provide support after any immediate sell-off because it also means there is increased liquidity in the stock – which financial institutions and large investors like.

Liquidity can be restrained during the lock-up period because it is not uncommon for the majority of a stock’s shares to be subject to it, which could mean they don’t initially meet the criteria demanded by the likes of institutions or pension funds.

There is no definitive answer to how the end of a lock-up period will impact share prices. Every stock is different – some will suffer, others will benefit. What we can safely presume is that the end of a lock-up period will lead to increased volatility in the stock over the short term.

What happens to share prices when the lock-up period ends?

Social media site Pinterest and video conferencing company Zoom both went public on 18 April 2019, and saw their lock-up periods expire on 15 October 2019.

Pinterest shares closed at just under $27 per share on Friday October 11 – nearly 42% higher than its IPO price of $19. However, shares began to lose value when the new week began and lost 3.8% by the time trading closed at the end of Monday October 14 – the day before the lock-up period expired.

The following day, when lock-up shares could be freely sold, shares lost as much as 4.9%. However, they recovered much of that loss by the end of the day and closed 1.1% lower than the day before.

Zoom shares also began to lose ground the day before the lock-up period expired, losing about 0.8%. Shares fell by as much as 3% the following day once the lock-up expired but ended the day up by 0.4%.

However, there was an even sharper sell-off the day after the lock-up expired, with shares plunging by more than 6%. One reason Zoom’s share price could have suffered more than Pinterest’s is the fact shares had almost doubled between the IPO and the lock-up period expiring, enticing more of its investors to cash-in.

Both examples suggest that the end of a lock-up period does place very short-term selling pressure on a stock as expected.

Another worthwhile (but different) example would be Jumia Technologies, which unlike Pinterest and Zoom had seen its share price roughly half between launching its IPO and the end of its lock-up period on 9 October.

Again, shares began to fall in the days before the lock-up period expired and saw that accelerate when it ended. Jumia shares plunged by nearly 18% over the four days from the lock-up expiring – hitting an all-time low. But shares bounced back and recovered those losses, supporting the theory that the end of a lock-up period

How to forecast the effect of a lock-up period expiring on the share price

  • How does the share price perform in the days before the lock-up period expires? This usually shows how other investors expect the expiration of the lock-up period to impact the share price.
  • How has the share price performed since the IPO? If shares have rallied since listing, then this could entice investors to sell shares once the lock-up period expires. If it has tanked then this could discourage them from selling, but it could also entice them to reduce their exposure and cut some of their losses. Remember, their entry point will be lower than the IPO price, so they can still sell at a profit even if the share price has performed badly since listing.
  • How is the business performing? Many of this year’s largest IPOs have been companies that have questionable business models, such as Uber, which has confessed it may never be profitable. In the current climate where uncertainty reigns supreme, investors are looking for safer bets and have less of an appetite for riskier investments like high-growth but unprofitable businesses. This could encourage a larger sell-off once the lock-up period expires as investors look to redeploy their cash to safer alternatives. Remember, lock-up investors have not been able to respond to any news since the IPO.
  • How many shares are subject to the lock-up period? The number of shares subject to a lock-up is usually quite large. Take SciPlay as an example. Before it went public, only 22 million shares were freely tradeable on the open market. But once the lock-up period expired on 30 October, a staggering 104.3 million more shares entered the market. The more of a company’s share capital that is subject to the lock-up period, the greater the potential selling pressure will be.
  • Who owns the shares subject to the lock-up period? Understanding who owns the shares subject to the lock-up can provide further insight as to whether they will look to sell down their stake when it expires. Consider the strategy behind each shareholder’s stake and why they own it. For example, if the majority of lock-up shares are owned by founders and management, then they are less likely to sell large stakes compared to institutions or funds that have invested early on. If employees have been paid in shares, then they will cash in at the first opportunity.

How to trade upcoming IPO lock-up periods

There are a few ways to trade the expiration of a lock-up periods following an IPO. If you believe the stock is going to suffer as a result of the lock-up period expiring, then you could short the stock in the days beforehand. You could do this using an IG’s spread betting or CFD accounts, which also allow you to utilise leverage.

Read more: What is the difference between spread betting and CFDs?

For investors, it could present a different opportunity. If you missed out on buying any shares when a stock conducted its IPO, or feel like you have been priced out, then any knock to the share price when the lock-up period expires could present an opportunity to buy at a cheaper price.

This only applies if you believe in the stock over the long term and want to get a cheaper entry point. You can use an IG share dealing account to do this and will own the shares outright, benefiting from any appreciation in price as well as any dividends that are paid.

If you want to try your strategy out risk-free then you can open an IG demo account first before opening an IG live account.

Read more about IPOs:

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