IPOs, SPACs, Meme Stocks, and Speculation

New listings, hot tickers, and lottery-shaped bets share a common feature: they are enormously appealing and, on average, they lose to a plain index fund. This guide walks through the actual return evidence, explains the mechanics that transfer money from late buyers to early ones, and lays out harm reduction rules for people who are going to speculate anyway.

By Karanvir Singh, founder of Quantix Invest

Why these bets feel different

Nobody speculates because they have carefully concluded that lottery-shaped assets have superior expected returns. They speculate because index investing is slow and boring, because a friend just made 400%, and because the story attached to a new company is far more vivid than the story attached to owning 3,500 companies at once.

That pull is not irrational in the psychological sense. It is very well documented. People systematically overweight small probabilities of large payoffs, a finding that runs from Kahneman and Tversky's prospect theory through decades of empirical asset pricing work on what is called the lottery preference. Investors will pay too much for a small chance at a huge gain, and the assets that offer that shape (very cheap stocks, high-volatility names, far out-of-the-money options, new listings, anything with a narrative) systematically earn lower average returns because of it.

That is the through line for this entire guide. IPOs, SPACs, meme stocks, and short-dated options are structurally different products, but they all sell the same shape, and they all get overpriced for the same reason.

How an IPO actually works

A private company hires investment banks to underwrite an initial public offering. Over several months, the company files a registration statement (the S-1) with the Securities and Exchange Commission, sets a preliminary price range, and goes on a roadshow to institutional investors. The banks collect indications of interest, build a book of demand, and the night before trading begins they set a final offer price and allocate shares.

Here is the part that matters. You almost certainly do not buy at the offer price. Allocations at the offer go to institutional clients and favored accounts. When the stock opens for public trading the next morning, it often opens well above the offer. The price a retail investor pays is the opening market price, not the offer price, and the gap between them is a real, measurable transfer.

Some brokers now offer retail access to a slice of IPO allocations. Read the terms carefully. Allocations are typically small, often come with soft expectations about not selling immediately ("flipping"), and access tends to be widest for the deals with the least institutional demand. An allocation you can easily get is information about the deal.

The first-day pop and who gets it

IPO underpricing is one of the most persistent, most documented phenomena in finance. Jay Ritter of the University of Florida has maintained the definitive data set for decades. The broad picture across thousands of US IPOs since the 1980s: average first-day returns of roughly 18% to 20%, with wild variation by era. The 1999 to 2000 window averaged around 65% first-day returns; a number of years since have averaged in the low teens; 2020 and 2021 spiked again.

Worked example of the transfer. A company sells 20 million shares at an offer price of $20, raising $400 million gross, minus underwriting fees of typically 7% for smaller deals.

• Gross proceeds: 20,000,000 x $20 = $400,000,000
• Underwriting fee at 7%: $28,000,000
• Net to the company: $372,000,000

The stock opens at $35 and closes the first day at $38, a 90% first-day return on the offer price.

• Allocated institutions gained 20,000,000 x ($38 minus $20) = $360,000,000 in one day.
• The company left roughly that same amount on the table: it could have sold the same shares for far more. This is the "money left on the table" figure Ritter tracks, and in hot years it runs into the tens of billions of dollars.
• The retail investor who bought at the $35 open and held to the $38 close made 8.6%, on a day the headline said 90%.

Now read the headline again: "IPO soars 90% on debut." Almost nobody reading that headline captured 90%. That return belonged to people who received an allocation, which is to say, to people who were already institutional clients.

The long-run IPO evidence

Buying at the open is where the record turns unfavorable. The academic literature on long-run IPO performance is remarkably consistent across decades and countries, and it goes back to Ritter's 1991 paper documenting what he called the long-run underperformance of initial public offerings.

The typical finding, measured from the first closing price and running three to five years:

• IPOs as a group underperform comparable seasoned firms of similar size and style by several percentage points per year.
• The median IPO substantially underperforms the market, while the mean is dragged upward by a small number of enormous winners. The distribution is severely right-skewed, which is exactly the lottery shape.
• Underperformance is worst for the deals that came in the hottest markets, for younger companies, for companies without earnings, and for the deals with the largest first-day pops.
• Bessembinder's work on lifetime stock returns reinforces the shape from another direction: a small minority of stocks account for essentially all net market wealth creation, and the majority of individual stocks underperform Treasury bills over their lifetimes. New, small, unprofitable companies are heavily represented in that majority.

This is not a claim that no IPO is worth owning. Some of the largest companies in the world were once new listings, and someone who bought at the open and held for twenty years did very well. The claim is about the average and the median, and about the fact that you cannot identify the exceptions in advance any better than the professionals who priced the deal.

There is also a survivorship illusion at work. You remember the IPOs that became household names. You do not remember the several thousand that were delisted, acquired at a discount, or drifted to a fraction of their offer price. The 2020 to 2021 cohort provides an unusually clean recent test: a large share of the companies that went public in that window, both traditional IPOs and SPAC mergers, traded well below their debut prices two and three years later, in many cases down 70% to 95%, during a period when the broad market itself recovered and made new highs.

Lockups, dilution, and the six-month cliff

Insiders, employees, and pre-IPO investors are typically restricted from selling for 90 to 180 days after the offering, with 180 days being the common standard. This is the lockup period, and it is contractual, disclosed in the prospectus, and worth reading.

Two consequences follow. First, the float in the weeks after an IPO is often a small fraction of shares outstanding, sometimes under 10%. A small float with high demand can produce dramatic prices that have little to do with the company's value, because supply is artificially constrained. Second, when the lockup expires, that constraint disappears at once. Studies of lockup expirations find a statistically significant negative abnormal return around the expiration date, typically in the range of one to three percent on average, and considerably larger for stocks with high insider ownership and no earnings.

Modern deals complicate this: many now use staggered lockups with early-release triggers tied to price thresholds or earnings dates, and direct listings skip the traditional lockup structure entirely. The general principle survives. Know when the sellers arrive. The prospectus tells you the date and the number of shares.

Dilution is the companion issue. Employee stock option pools, restricted stock units vesting on a schedule, convertible instruments, and follow-on offerings all increase the share count over time. A company whose share count grows 5% per year needs earnings to grow 5% per year just to keep earnings per share flat. Look for the fully diluted share count in the filings, not just basic shares, and check the year over year trend.

SPACs: the structure that ate the returns

A special purpose acquisition company is a shell that raises money in an IPO at, conventionally, $10.00 per unit, then has roughly two years to find a private company to merge with. If it finds nothing, the trust is returned to shareholders. If it finds a target, public shareholders vote and, importantly, can redeem their shares for the trust value instead of participating.

The structure has an obvious appeal for a private company: it is a faster route to being public, with more latitude to publish forward-looking projections than a traditional IPO allows. The problem was always on the investor side, and it is arithmetic rather than opinion.

Worked example of SPAC dilution. A SPAC raises $300 million by selling 30 million shares at $10.00 into a trust.

• Sponsor promote: the sponsor typically receives founder shares equal to 20% of the public shares for a nominal amount, here 7.5 million shares (20% of the 37.5 million post-promote total). Cost to the sponsor: roughly $25,000.
• Underwriting and deal fees: commonly around 5.5% of the raise across the IPO and deferred merger fee, call it $16.5 million.
• Warrants: units usually include warrants that become additional shares if the stock rises, further diluting whoever holds common stock.
• Redemptions: before a merger closes, many public holders redeem at roughly $10 plus interest, taking cash out of the trust. In 2022, average redemption rates across completed deals exceeded 80%.

Put those together. Suppose 80% of holders redeem, leaving $60 million of the original $300 million in trust. The sponsor still holds 7.5 million promote shares. The company gets far less cash than the headline suggested, and the remaining public shareholders own a company whose share count includes a large block issued for essentially nothing. Research from Klausner, Ohlrogge, and Ruan quantified this: the cash actually delivered per share at merger was frequently far below the nominal $10, often in the range of $4 to $6, with the difference absorbed by the promote, fees, and warrant dilution.

The outcome record matched the structure. Studies of the 2019 to 2021 SPAC wave found that post-merger share prices for the median deal fell sharply within a year, with typical declines from the $10 reference of 30% to 70%, while the sponsors, who bought in at nominal cost, could profit even from deals that lost most of their value for everyone else.

Worth noting the exception for completeness: buying SPAC shares near the trust value before a deal is announced, and redeeming rather than participating, was a low-risk arbitrage that some funds ran successfully. That is a cash-management trade in a shell, not an investment in a business, and it is not what retail investors were doing.

The lottery preference: why cheap upside is expensive

Bring the thread together. Across many asset classes, securities with the highest probability of a spectacular gain earn the lowest average returns. The finance literature calls the measurable version of this maximum daily return or skewness preference. Bali, Cakici, and Whitelaw's work found that stocks with the highest recent maximum single-day return went on to earn substantially lower returns than otherwise similar stocks.

The mechanism is straightforward. Assets with lottery-like payoffs attract crowds of buyers who want that shape. The crowd bids the price up. A higher price today, with unchanged future cash flows, means a lower future return. The excitement is capitalized into the price.

The same logic explains the low volatility anomaly from the other side: boring, stable, unglamorous stocks have historically delivered returns at least as good as high-volatility ones despite far less risk, in part because nobody wants to hold them and because leverage constraints push return-seeking investors into volatile names instead of levering safe ones.

The practical translation is uncomfortable but simple. The characteristics that make an investment fun to own (a new company, a big story, a chart that moved 40% last week, a possible ten-bagger) are the same characteristics associated with lower average returns. You are not being paid extra for risk here. You are paying extra for entertainment.

Meme stocks and the short squeeze

The 2021 episodes made the mechanics visible. A heavily shorted small company attracted coordinated retail buying, which forced short sellers to cover (see the margin and leverage guide for why covering is mandatory rather than optional), which pushed prices higher, which forced more covering. The loop produced gains of several thousand percent over weeks.

Three things are true about that episode simultaneously, and most commentary picks one.

1. The squeeze was real and some people made life-changing money. Early buyers who sold near the top captured enormous returns.
2. The squeeze was a wealth transfer, not wealth creation. The underlying businesses did not become worth what the market briefly said. The money that early sellers made came from later buyers and from short sellers, and the later buyers were overwhelmingly other retail investors.
3. The aggregate outcome for retail was negative. Academic studies of the episode, and later brokerage data, found that the largest inflows of retail money arrived near the peaks. The distribution of individual outcomes was, once again, severely right-skewed: a few large winners, a long tail of losses.

The durable lesson has nothing to do with any particular ticker. It is that a price driven by forced buying and social momentum is a price with no anchor, and the moment the forcing mechanism finishes (shorts covered, attention moves on) the only remaining support is what the business is actually worth. That reversion is not a bug in the story. It is the story.

Options as retail speculation

Retail options volume grew enormously through the 2020s, concentrated in very short-dated contracts, including options expiring the same day. The appeal is obvious: a contract costing $50 can be worth $500 by the afternoon.

The evidence on how this works out is not ambiguous. Studies of retail option activity have consistently found aggregate losses, with typical figures showing retail buyers of short-dated options losing a meaningful percentage of premium in aggregate, driven by three costs that stack:

• The bid-ask spread. On low-priced options, spreads of several percent per round trip are normal, and they are paid every single trade.
• Time decay. An option is a wasting asset. Short-dated out-of-the-money options lose value every day the underlying does not move, and the decay accelerates toward expiration.
• The volatility premium. Implied volatility on average exceeds subsequently realized volatility, which means option buyers on average pay more than the statistical value of the payoff. That premium is the compensation earned by the sellers, who are typically professional market makers.

Worked example. Buy 10 contracts of a weekly call at $0.50, so $500 of premium plus commissions. To break even you need the option to be worth $0.50 at some point you actually sell. If the spread is $0.45 bid and $0.55 ask, you bought at $0.55 and can immediately sell at $0.45, an instant 18% loss on entry. The stock now has to move enough, fast enough, to overcome an 18% starting hole plus daily decay. Do this fifty times a year with a genuine 50/50 directional skill and the spread alone guarantees a losing record.

Options are not inherently a scam, and covered calls, protective puts, and hedging uses are legitimate. The specific activity that reliably loses money is buying short-dated out-of-the-money contracts for directional speculation, at retail spreads, repeatedly.

Crypto and the same pattern in new clothes

Cryptocurrency deserves a note here because the token-launch ecosystem reproduces every mechanic above with less disclosure. A new token launch is an IPO without an S-1 or audited financials. The insider allocation is the promote. The vesting schedule is the lockup. The listing pop, the concentrated float, the cliff when early holders can sell, and the right-skewed distribution of outcomes are all identical.

The differences make it harder, not easier: no standardized financial reporting, no requirement to disclose insider holdings, trading venues with variable custody practices, and, on some platforms, advertised leverage that guarantees liquidation on small adverse moves. Whatever one believes about the long-term prospects of the major protocols, the launch-and-hype layer is a lottery-preference machine with the disclosure regime removed.

Harm reduction rules

Telling people never to speculate has a poor track record, in the same way that abstinence-only advice generally does. If you are going to do it, these rules meaningfully reduce the damage. They are all mechanical, which is the point, because in-the-moment judgment is exactly what fails.

1. Separate the accounts. Open a distinct brokerage account for speculation. The core portfolio, the retirement accounts, and the emergency fund are not in it, are not visible in the same app screen, and are never a source of funds for it.
2. Cap it at a number you can say out loud. A common ceiling is 5% of investable assets, and 10% is the outer limit anyone should defend. Below 5%, even a total loss is a bad year, not a changed life.
3. Fund it once, on a schedule, never on impulse. Decide the annual funding amount in advance. If the account goes to zero, it waits until the next scheduled funding date. No topping up in the middle of a drawdown, which is precisely the moment the urge is strongest.
4. Never use leverage or margin in it. Speculative positions plus borrowed money is the specific combination that turns a capped loss into an uncapped one.
5. Size any single position so a total loss is survivable. If one position going to zero would be materially painful, it is too large. A useful check: would you be able to describe the loss to your spouse in a normal tone of voice?
6. Write the thesis and the exit before you buy. Three sentences: what I think happens, what would prove me wrong, and what price or date makes me exit. Written in advance, saved, dated. This alone eliminates most of the "I will just hold until it comes back" losses.
7. Wait 48 hours on anything you learned about from a video, a forum post, or a group chat. Nearly all of the lottery premium accrues to whoever bought before you saw it. If it is still a good idea in two days, you have lost almost nothing by waiting.
8. Track every trade and total the results honestly, including taxes. Most people who believe they are ahead have not counted the losers or the short-term tax rate. Keep a spreadsheet with entry, exit, and realized result. Compare the total, at least annually, to what a broad index fund would have done with the same money on the same dates. This benchmark is the single most clarifying habit available.
9. Respect the tax mechanics. Speculative gains are usually short-term, taxed at ordinary income rates, and losses beyond your gains deduct only $3,000 per year against ordinary income, with the rest carried forward. Wash sale rules can disallow losses if you rebuy within 30 days. A profitable-looking year can be an unprofitable one after tax.
10. Set a hard stop on the activity itself. Decide in advance what would make you stop entirely: a loss threshold, chasing losses, trading during work hours, or hiding it. If gambling behaviors appear, treat them as gambling behaviors rather than investing ones. In the US, the National Council on Problem Gambling helpline is 1-800-522-4700, and it covers trading.

Common mistakes and the bottom line

Reading the first-day pop as your return. Headline IPO gains are measured from the offer price, which you did not get.

Confusing a great company with a great investment. A company can be genuinely excellent and still be a poor investment at a price that already assumes excellence. The price is the whole question.

Ignoring the share count. Lockup expirations, warrant exercise, sponsor promotes, and employee equity all put more shares into the market. Value per share depends on the denominator.

Judging your record by your best trade. Memory is selective and speculative outcomes are right-skewed, so almost everyone remembers themselves as roughly break-even when they are not. Only the spreadsheet knows.

Believing you are early. By the time an opportunity is broadly visible, the people who were early are looking for someone to sell to. Ask honestly what makes you think you are the buyer with an edge rather than the exit liquidity.

Letting a winner rewrite the rules. One large gain reliably causes people to raise their position sizes, drop their caps, and add leverage. That is how a 5% allocation becomes a 40% one, and it is the most common path from a fun hobby to a serious loss.

Treating the absence of a crash as evidence of skill. Bull markets make speculation look easy for years at a time. The strategy is only evaluated when conditions change.

This guide is educational material, not individualized financial advice, and nothing here is a recommendation to buy or avoid any specific security.

Related guides: Analyzing a Stock, How Markets Work, Understanding Risk, Index Funds, Mutual Funds, and ETFs