Internet Mania

By Daniel Kadlec

Amazon.com the money-losing online book-seller whose market value now greatly exceeds that of Sears, may be the most outrageous example of Internet speculation. But it has plenty of company inside the bubble. Online auctioneer eBay, trading publicly only since September, is up tenfold and is now six times as big as venerable bricks-and-mortar auction house Sotheby's. Without question, Internet stocks are the hottest things since biotechnology shares soared in 1991 (and crashed in 1992), and may be the hottest things since the Dutch tulip-bulb craze in the 1600s.

But don't get me wrong. I agree with the cheerleaders that the Net will transform our world--just not overnight. The hype is out of control, and even the Netxecutives acknowledge it. They have been selling their own stock lately, and the pace will quicken in coming months as these insiders become free to trade tens of millions of "locked up" shares resulting from recent IPOs. If you have a pulse, you've wondered how much longer prices can remain untethered to any valuation benchmark. You may also have wondered how you can profit when many Net stocks inevitably fall.

You have two basic choices: to sell short, which means borrowing shares from a broker and selling them in the hope that you can later buy them back lower and pocket the difference; or to buy "put" options giving you the right to sell stock at a preset price by a preset date. These are simple trades that any broker can handle. But each poses problems that are magnified with Net stocks.

The main risk in selling short is that your potential losses are unlimited. There is no telling how high a stock will go. If you had sold short 100 shares of eBay just a month ago, you would have a paper loss today of $12,000. Professionals have lost hundreds of millions betting against Net mania. Compounding the problem, Net stocks have relatively few shares in circulation, and that makes them difficult to borrow and sell. The ones you would want to short--those without earnings or a compelling business plan--are precisely the ones whose shares are hardest to borrow. You can easily short AOL, but it has a real business and is least likely to plunge. Available shorts include portal companies, among them Yahoo and Excite. But again, they're not first choice.

Put options are less risky. The price of the option is all you can lose. But options tend to be short-term vehicles, expiring within three or four months. You need a long-term strategy because manias tend to last longer than anyone expects. Compounding the problem, options on Net stocks are insanely expensive, costing double or triple what they cost on other stocks.

There are three Net indexes on which you can buy put options: Amex Inter@ctive Week, Goldman Sachs and TheStreet.com The Amex also sells long-term options (LEAPS) on individual stocks, including aol, Yahoo, @Home and Ascend. Those expire in January 2001 and give plenty of time for the bubble to burst. But the stock would have to fall 50% in that time for the LEAP to pay big.

The safest move is simply to avoid the Net stocks or make a backdoor bet on established firms that don't have .com in their names but are making money off the Net anyway. Those include Cisco and Lucent, which make the equipment that runs the Net, and Federal Express, which delivers much of the stuff we're buying online.

See time.com/personal for more on Internet mania. E-mail Dan at kadlec@time.com See him on cnnfn at 12:45 p.m. E.T. Tuesday.