Why MicroStrategy Stock Plunged This Week

Shares of MicroStrategy (NASDAQ: MSTR) fell as much as 20.8% in the first four trading days this week as the price of Bitcoin dropped and the company's premium to assets on the balance sheet came down. On Friday morning, shares were still down 22.5% for the week in pre-market trading, according to data provided by S&P Global Market Intelligence.

MicroStrategy and Bitcoin

What MicroStrategy is trying to do is use its stock to purchase more Bitcoin and increase the amount of Bitcoin held per share. The strategy works if MicroStrategy's stock trades for a premium to the value of Bitcoin held per share. MicroStrategy can issue shares to buy Bitcoin, increasing the amount of Bitcoin per share and also likely increasing the price of Bitcoin by taking more supply off the market.

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The strategy works until there's no premium or when Bitcoin falls. This week, both happened. Bitcoin is down 5.5% over the past seven days as I'm writing and MicroStrategy's large drop indicates the premium is falling as well.

CEO Michael Saylor's dangerous game

The strategy to use MicroStrategy's stock as an arbitrage to Bitcoin's price is a dangerous one long-term. Stocks that are valued based on an underlying asset like Bitcoin don't typically trade for a premium to the assets they hold, so this is an unusual situation. And that premium collapsing could send MicroStrategy's stock sharply lower.

MicroStrategy has also been by far the biggest buyer of Bitcoin on the open market, holding up the price. If it doesn't have a premium with which to issue shares and demand for Bitcoin falls, that could be a double whammy to the stock. I don't think the drop is over for MicroStrategy as the trade the company has used to become a popular stock starts to unwind.

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Travis Hoium has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.