Midweek option activity indicated a bear on the prowl in 3D Systems Corp. (DDD) – one of the handful of 3D-printing companies featured in Barron’s last weekend. Others in the space mentioned include Stratasys (SSYS), ExOne (XONE) and Voxeljet (VJET). The magazine questioned whether investors’ fascination with such stocks completely missed the point that while 3D printing offers the potential to change the landscape of US manufacturing, such potential is not addressed by these companies. Investors, it suggests, are therefore overpaying for the privilege of owning those printing stocks.
Midweek our option market scanner picked up increased activity in a conversion trade – the creation of a ‘hedged’ long position, which acts just like an interest rate spread. The conversion play is not so much aimed at capturing a price move in the stock as it is geared towards the cost of carry. By Wednesday shares in 3D Systems had slumped 12% in response to the Barron’s article adding to a slide since February 21st through last weekend to 18.3%. The following chart shows how shares became increasingly costly to borrow during a short squeeze in the three weeks prior to that latest peak. The lack of available shares to borrow between short sellers forced up the cost of borrowing during that period to 33%, while prior to the squeeze holders routinely made their stock available at a cost frequently below 1.5%.
Chart – 3D Systems slid but its borrowing cost remained steady
The conversion trade involved the purchase of stock while simultaneously selling 2,000 calls and purchasing 2,000 put options both expiring 16 April ‘14 at the $60 strike – just around where its shares were trading at the time. The cost of borrowing shares in order to facilitate a short play according to IB data, has since fallen from its highs to a more palatable 5.5%. The terms of the recent conversion trade leaves the trader immune to the share price movement going forward, yet locks into a fixed borrowing cost. From what we can tell, the $0.90 premium implies a borrowing cost in the region of 7.5%.
A trader might do this because of the perception that borrowing costs will rise caused by either another short squeeze or greater willingness to short the stock among speculators. If this turns out to be the case the conversion trader would benefit regardless of the direction and assuming the trade can be unwound at the resultant higher borrowing structure. Perhaps most important of all to the potential short seller is the certainty that a conversion trade offers by locking into inventory that has previously proven hard-to-borrow. The investor could possibly await better prices or key record dates that might even make borrow inventory scarce just as demand is peaking.