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Short sellers test the waters on Twitter

Wednesday, 13 Nov 2013 | 5:28 PM ET
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Short sellers are starting to circle around Twitter shares in their first chance at betting against the micro-blogging site's stock, a sign some investors think the share price will fall.

Data on Wednesday showed the cost to borrow Twitter shares jumped from 5 percent to about 13 percent on an annualized basis, after having touched 20 percent earlier in the day. About 5.5 million shares were out on loan.

The current cost to borrow indicates interest to short the stock is "definitely high" according to Timothy Smith, executive vice president at SunGard's Astec Analytics, the provider of the data. The short interest is "red hot, but not white hot," he said.

(Read more: Opening price for Twitter keeps on going higher)

At this point, it appears unlikely that Twitter will be a repeat of the tidal wave of negative bets that dogged Facebook after its debut last year. Smith noted that shortly after Facebook shares debuted in May 2012, the cost to borrow was between 40 percent and 50 percent on an annualized basis.

However, Smith said, "No two stocks are the same notwithstanding any desire to compare to other stock IPOs such as Facebook or LinkedIn.

"There are three things that can be stated though: there is scrutiny, there is short selling and there is availability to borrow."

(Read more: Stay away from Twitter, advisors say in survey)

Short sellers borrow shares and sell them in the expectation of a price drop. They profit from such a fall by selling the borrowed stock, later buying it back at the lower price. It is also used as a hedging strategy.

"I know there are a fair number of people that do believe Twitter is over-valued and will be looking to short the stock," said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles.

Shorting is "certainly not something we are encouraging," he said. Wedbush has a neutral rating and a $37 price target on the stock.

(Read more: When parents discover Twitter, teens get lost)

Twitter shares rose 1.7 percent on Wednesday to close at $42.60, about 64 percent higher than the IPO price of $26 per share a week ago. In its first day of trading the stock opened at $45.10 a share and touched a high of $50.09 before pulling back.

Gearing up for options

If the cost to borrow Twitter shares remains high, it could boost volume when Twitter options begin trading on Friday.

"Anyone looking to short the stock could use puts and those who have stock that is locked up could use the options market to exit long stock positions," said Andrew Keene, president of options trading firm KeeneOnTheMarket.com in Chicago.

Buy or hold recommendations from research analysts on Wall Street outnumber advice to sell Twitter shares by 11 to two according to Reuters data. The price target on Twitter shares ranges from $20 to $54.

Twitter's valuation, measured as its enterprise value compared to earnings before interest, taxes, depreciation, and amortization is estimated at a whopping 176.7 times for the next 12 months according to Reuters data. That compares to 18.1 for the same measure on Facebook, 11.3 for Google and 74.8 for Yelp.

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