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To print article, click Print on your browser's File menu. Go back Posted 1/15/2004 |
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Breaking News For the latest merger news, see the CNBC Market Dispatch |
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Extra Suspicious trading preceded bank megamerger Exchanges saw a huge spike in the purchase of Bank One options even before news of the huge J.P. Morgan acquisition broke. The transactions were enormously profitable for a fortunate few. By Michael Brush Though Wall Street is struggling to clean up its image, little has really changed -- judging by the huge spike in the volume of stock options that became extremely profitable once news broke Wednesday of a proposed takeover of Bank One The juiciest gains? Those were pocketed by speculators who scooped up Bank One call options Traders who bought those call option contracts for just a nickel per contract Wednesday could sell them for anywhere between $4 and $2.85 per contract Thursday, observes Christopher Johnson, the director of quantitative analysis at Schaeffers Investment Research, an options firm based in Cincinnati. "That is what we call a big hit in this business," says Johnson.
Call options give investors the right to purchase a stock at a pre-arranged strike price, and the potential for profits is enormous. If you bought 1,000 of those Bank One call options Wednesday for five cents per contract, you would have paid $5,000 ($.05 x 100 shares per contract x 1,000 contracts). The next day you could have sold them for $342,000 ($3.42 median price x 100 shares x 1,000 contracts). In short, since call options offer speculators much greater leverage than plays on the actual stock, they are the place to lay your bets if you expect a quick move up in a stock price. Thats what speculators were doing Wednesday, right up to time the news broke about 4 p.m. ET that J.P. Morgan Chase planned to buy Bank One. That extremely profitable January call option on Bank One shares that went to $4 per contract from five cents? It traded over 3,000 contracts Wednesday ahead of the merger news -- compared to a typical daily volume of around 40 or 50 contracts over the past few weeks. Most of the volume in this contract took place after 3:30 p.m. Wednesday -- a half hour before news of the big bank merger was made public. Outside of two trades, everything happened between 3:30 p.m. and 3:45 p.m., says Johnson. Breaking the news News of the merger was broken by the Wall Street Journal on CNBC airwaves at around 4 p.m. Wednesday. Within minutes, financial news wires like Reuters, Bloomberg and Dow Jones were running the story. The companies officially released news of the merger at around 5:40 p.m. Another option that showed unusually high volume was the Bank One call option All told, Bank One call option volume spiked to over 10,000 shares Wednesday. Thats around 10 times the volume on a typical day over the past several weeks, says Phil Erlanger, a technical analyst at Erlanger Squeeze Play. Does all this prove that Wall Street is still up to its old ways of profiting on inside information? The Chicago Board Options Exchange and the Securities and Exchange Commission both declined to comment on whether they were looking into suspicious volume in Bank One call options. But skeptics like Erlanger have little doubt. "I would say 100% that someone knew ahead of time and traded options on it," he says. "If it walks like a duck and quacks like a duck, its a duck." Given the lack of unusual option activity in any of the other major banks in the days before the Bank One news broke, its unlikely the purchase of Bank One call options was part of some scattershot play on possible bank mergers that afternoon. Unfortunately, it may be unlikely that Wall Street cops can convict any traders who made money buying Bank One call options in the days before the takeover news broke. As suspicious as the trades look, the speculators may not have done anything wrong. Or it may be difficult to prove if they did. Legal issues To prove illegal trading, prosecutors have to show that the traders acted on material, non-public information from a source who they realized, or should have realized, was breaching his or her fiduciary duty in disclosing that information, says John Coffee, a corporate law professor at Columbia Law School. Fiduciary duty refers to the obligation of senior management to put the interests of shareholders above all other interests. By letting news of a deal slip to a select few, managers would violate the interests of any shareholders who sell at lower prices before the stock rockets on full public disclosure of the news. Lawyers and investment bankers also have a fiduciary duty not to disclose news of a proposed merger ahead of time, says Coffee. But if speculators scooping up Bank One call options ahead of the news can show they got the news from someone lower down the ladder who didn't have a fiduciary duty to keep quiet, or that they were acting on market rumors, they may be off the hook. Enticingly, Lehman Brothers analyst Brock Vandervliet dropped the following line in a report on Jan. 9, just a few days before the merger news came out. Although we do not have any sense for the probability of it actually occurring, wrote Vandervliet, one transaction that would be potentially extremely compelling would be a merger of JPM and ONE, a market driven business model (JPM) with a low risk more traditional model (ONE). At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. |
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