The crowning moment of a generally down trend for the stock market this week was the phenomenal 19.2% drop in eBay stock yesterday. Normally the performance of one stock in a large and balanced portfolio wouldn’t have gotten my attention, but because eBay has been doing so well I put a pretty large chunk of money into it and it split last year and made that investment even bigger, so that drop certainly got my attention.
The price had been going high enough that I was hoping for another split in the next quarter. A big, sudden drop was not at all what I expected. As a relatively conservative investor who manages his own portfolio I don’t deal much with the more speculative aspects of investing, including trading on the options market, which I was franly barely aware of. I mean, I know how options work and I know you can trade them, but it’s not something I’m likely to venture into. As it turns out this drop is eBay is all about the options. Apparently eBay had some outstanding options which were set to expire today, which were trading at about 55 cents and would allow you to buy eBay shares at $85, which was about $20 below what it was trading at first thing yesterday.
So it seems that a lot of people who had been betting on eBay as a growth stock decided to sell their eBay shares to raise money to buy these expiring options which they plan to use today to buy more eBay, speculating that the price will be above $85 today and they will make an instant profit. Of course, that rapid sell-off lowered the price to $83.33 by the end of the day Thursday and normal trading has only increased eBay by an average of 2% per day. If you add $83.33+$.55+$1.67 you get a price of $85.55, exactly what the speculators will have paid for their option shares once all is said and done. So if eBay does any better than that 2% increase today they make money. If it does worse they lose money, though if they hold the shares for more than a day it seems almost impossible for them not to profit substantially.
What they’re counting on is that with the lowered price people like me will scramble to buy more eBay shares at the lower price, so there will be a giant run on eBay today and the stock will shoot up more than 2% and they’ll make a bundle on their options. It’s not an unreasonable theory. Of course it’s also a classic example of manipulating the market for profit, which is very American but a little scary. What I find most remarkable is the fact that the price decline on Thursday stopped at exactly the $83.33 price which was the perfect break-even point. It’s a big market and there are a lot of eBay shares out there. How on earth did the final price end up at what can only be seen as the perfect number? Is it possible that someone or some group of traders own so much eBay that they could sell it in bundles during the course of the day to control where the price ended up? That’s a scary thought.
I’m not actually that worried about the situation. Even with its recent slightly disappointing earnings report, eBay will come back strong. If it doesn’t rally as hard as we would like today, it will rise steadily next week and eventually get back to where it was. Not as exciting for speculators, but fine for long term investors like me who are confident in eBay’s business model. The only question for me is whether I should free up some money and buy more eBay while it’s down or just hold on and see what happens. I’m not in the same advantageous position as those with options, but with the price where it is there’s the possibility for profit for anyone with money to invest.
Whatever I do, this situation with eBay is a fascinating example of how the market works and how there are potentially enormous amounts of money to be made if you have a lot of money to spend and take advantage of a sudden opportunity like this. My guess is that certain investors are going to have a few extra milion next week. The question is whether I’ll have a few extra thousand. Regardless of the outcome, it’s quite a dramatic process to observe. If I jump in and buy some more eBay I’ll post the results of my gamble here.
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