Unusual Options Activity: Speculating or Cheating?

07/30/2013 8:00 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Whether this is an example of incredibly lucky speculation or illegal trading activity is for others to determine, writes Alan Ellman of TheBlueCollarInvestor.com.

Covered call writers are average retail investors looking to generate monthly cash flow in small but consistent increments and then compounding those profits. In time, it could lead to financial independence. Other investors look to make a lot of money in a short-time frame by undertaking much greater risk than we do. Still others look to cash in using illegal activities. In today’s article I will ask you to draw your own conclusions.

The day is Friday July 12, and the stock is LEAP Wireless International Inc. (LEAP), which is a takeover candidate by AT&T. In the late afternoon, the share price was near $8 per share, the July $9 call option was priced @ $0.10, and the August $9 call @ $0.40. Covered call writers could generate an initial profit (ROO) of 1% and 5%, respectively. The average daily option trading volume for this company is 1320 contracts over the last three months. It appeared to be a normal trading day until the last hour of trading when option volume went through the roof. By day’s end, 7139 contracts were traded, all but 350 were calls as traders were taking a bullish stance on this stock. I think you know what’s coming!

After market close, there was an announcement of a takeover bid by AT&T for $15 per share, almost doubling the value of the share price. That would move the calls strike price $6 in-the-money. Here is a chart of LEAP showing the gap up in share price on July 12:

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LEAP share price gap up after July 12 announcement

Now here is the options chart for the August $9 call options:

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LEAP $9 call options gap up

According to Trade Alert, an option analytics company, there was unusual trading patterns in a three-minute window just before market close where substantial numbers of call options were purchased. I report, you decide.

I have been hypothesizing the past few years that the playing field for average retail investors is leveling off thanks to the hard work of the SEC and FINRA. Recently, the SEC has been investigating insider trading on Onyx Pharmaceuticals Inc. Assets and accounts have also been frozen for potential illegal trading on Smithfield Foods and Heinz Co.

So what does this all mean for Blue Collar Investors? Well that’s the good news…nothing negative for us. Had we taken a covered call position with LEAP, we would have generated the call premium plus any profit up to the strike price. The time value of the $9 call would then approach zero and we could have sold the stock and used the cash to generate a second income stream or at the very least, maxed out the trade.

Conclusion:
Whether this is an example of incredibly lucky speculation or illegal trading activity is for others to determine. I will be shocked if there is no investigation and those involved are innocent until proven guilty. As I say in my books and DVDs, we look to hit singles and doubles, not grand slam homeruns. The latter can be much too risky and could ultimately get us into trouble (wink, wink).

By Alan Ellman of TheBlueCollarInvestor.com

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