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Short the Internet? You Must Be Out of Your Mind

Don't fight the tape. The trend is your friend. Don't try to catch a falling knife.

There are plenty of axioms on Wall Street. With the major Internet stocks making twofold and threefold gains since June, the one you hear the most these days is: Don't get in front of a runaway train.

There are plenty of good, fundamental reasons for people to go short Internet stocks.'s



:Nasdaq) market cap, for example, is twice

Barnes & Noble's



:NYSE), after all -- and Barnes & Noble, with a price-to-earnings ratio of 57, is hardly undervalued. Amazon doesn't have the E necessary for a P/E, and indeed, of the major pure Internet plays, only




:Nasdaq), has actually shown earnings over the past year. If charges aren't taken out, even that isn't true.

Investors took some profits in the group today, sending Amazon down 17 1/2, or 12.5%, to 122 1/8;



down 10 3/4, or 10%, to 96 1/4; and Yahoo! down 8, or 4%, to 191. Still, nobody's calling a top. "Normally when a stock's down 8 bucks it's a big move, but in the Internet that's like half a point," said Dan Mathisson, head stock trader at

D.E. Shaw


Those who have gone short these stocks -- and short interest was high when it was last tallied on June 24 -- have felt intense pain. Hedge funds that stepped in front of the Internet stocks are rumored to be on the verge of going under. Even though most on the Street think that these stocks will fall to earth someday, they would rather play Russian roulette with five bullets in the chambers than go short now.

"If you're buying this thing on fundamentals, or shorting it on fundamentals, then you're gonna miss it because they're not trading on fundamentals," said one tech trader. "There are takeover hopes in them. There are split hopes -- Yahoo reports tomorrow and they have to say something. There's a big short squeeze. I think maybe they can come back in once those things are out of the way. Maybe the fundamentals will be the key then."

Or maybe not. Scott Tashman, managing partner of the hedge fund

Tashman Equity Partners

, thinks that there's so little Internet stock to go around, it's become a seller's market. "My feeling is you have a very unusual commodity in that you only have a handful of companies that you can truly participate in," he said. "You think about the people that want to own this stuff, the bottom line is there are not enough shares to satisfy the demand." The float on five major pure Internet plays -- Yahoo, Amazon, Excite,


TheStreet Recommends



:Nasdaq) and




:Nasdaq) -- totals 34.1 million shares. By contrast, the float on chewing gum purveyor




:NYSE) is 65.9 million shares.

Tashman contests the notion going around that the move in Internet stocks has been all about individual-investor buying, known as retail. One reason that idea has taken hold is that there are very few big blocks of these companies going by on the tape. Normally that points to retail, but because these stocks trade so thinly, and because it's so dangerous to go short even a little bit, market makers are willing to take on only smaller blocks. And institutions building positions, trying not to move the stocks too much, disguise their orders by buying only in dribs and drabs.

"These stocks wouldn't be moving if there weren't institutional buying," said one stock salesman. "I don't believe that it's only dentists. There's got to be all kinds of buying for stocks to go up this much."

"This is the whole point," said Tashman. "Everybody wants to own these things and there aren't enough shares to go around. I've never seen anything so demand-oriented in my life."

That's created a situation where there aren't many governors on how quickly the stocks can climb. "This is the kind of thing that can feed on itself," explained Mathisson. "One of the problems is that they're really hard to borrow. Even market makers have been getting called that they need to watch their short allocations."

Stocks are terrifically hard to short as a result, and the alternative, buying puts, is getting more expensive.

"The put prices are going up," said one Lycos trader on the

Pacific Exchange

after the sector had gotten knocked around in the afternoon. "Maybe they're reflecting the fact that the stock is becoming hard to borrow."

Options traders often will watch the implied volatilities of at-the-money calls and puts to determine whether the shares are getting difficult to short. The closer the premium levels, the easier the shares are to borrow, according to Dan Haugh, the president of

PTI Securities

, a Chicago brokerage firm that specializes in options. "If the exchange floors are having trouble shorting the stock, it will be reflected in the put prices," he said. "They'd be taking on more risk and need to be compensated for it." Haugh said retail investors might feel the shortage of shares early but floor brokers make a better indicator because their ability to short is generally better.

Near today's close, the implied volatility on Yahoo! at-the-money options was 96 for the call and the put; in Excite the call volatilities were at 97 while the puts were at 112; Lycos call volatilities were at the 119 level while the puts were at 126; and Amazon's puts were trading at a 125 volatility while the calls were around 115.

"The only way to play it is to write deep-in-the-money calls," said Mathisson. Using this strategy, which is safer at this point with August calls than with soon-to-expire Julys, the writer sells calls with a strike price well below the stock's current level. This avoids a high premium on the puts. "But there are risks in that as well," Mathisson added.

Indeed there are. Of the strategy, one Chicago wag cracked: "There are some nice premiums, but that trade looked good last week, too. And the week before, and the week before, and the week before, and the week before."

It isn't any wonder that people on the Street want to wait this one out.

"It's a sign of an unhealthy market that people are just chasing these stocks," said the salesman. "You just hope you're on board. If you're not, you hope you can buy them cheaper. I'm scared s***less of shorting them."