Unusual Options Activity: Speculation or Cheating?

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 12th 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 3 months. It appeared to be a normal trading day until the last hour of trading when option volume went through the roof. By days 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 12th:

LEAP share price gap up after July 12th announcement

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

LEAP $9 call options gap up

According to Trade Alert, an option analytics company, there was unusual trading patterns in a 3-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).

My next live seminar: The Money Show San Francisco:

August 16th: 9 AM and 6 PM

To register: https://secure.moneyshow.com/msc/SFMS/registration.asp?sid=SFMS13&newReg=t&scode=032230

Market tone:

This past week’s reports did nothing to change the bullish outlook this site has for our economy and for the stock market. The strengthening housing market is a major contributing factor to our assessment:

• Sales of existing homes were up 15.2% in June from a year ago
• In June, there was a 5.2 month inventory of homes for sale up slightly from the 5.0 in May
• The national median existing-home price in June was up 13.5% from a year ago @ $214,200. This represented the 16th consecutive month of year-over-year price increases
• The national average for a 30-year fixed rate mortgage rose to 4.07% in June, up from 3.54% in May and the highest level since June, 2012. Fed Chairman Bernanke promised to9 intervene if rising mortgage rates negatively impacted the housing recovery
• New home sales rose by 8.3% in June, the fastest pace since May, 2008 and 38% higher than a year ago
• The median sales price of new homes came in at $249,700, up 7.4% from a year ago but 10.3% lower than 1 month ago
• Durable goods orders ( A measure of the number of orders for a broad range of products—from computers and furniture to autos and defense aircraft—with an expected life of at least three years. Durable-goods orders are a leading indicator of industrial production and capital spending. Data fluctuate widely from month to month and are often subject to significant revision) rose by 4.2% in June much greater than the 1.2% expected by analysts

For the week, the S&P 500 was essentially flat for a year-to-date return of 20%, including dividends.

Summary:

IBD: Confirmed uptrend

BCI: Moderately bullish favoring out-of-the-money strikes 3-to-2

Wishing you the best in investing,

Alan ([email protected])

www.thebluecollarinvestor.com