Short-term bets on Bear stock reap rewards

NEW YORK (Reuters) - Traders who piled headlong into cheap Bear Stearns shares last week got rewarded on Monday with a windfall when JPMorgan Chase & Co lifted its buyout bid by a five-fold margin.

Bear's stock turned into a day trader's playground on March 14, when it announced a deterioration in its liquidity. On March 17, Bear agreed to a $2 a share deal to sell itself to JPMorgan. That was bumped up on Monday to $10 a share.

Hedge funds, arbitrage traders, Bear bondholders and those unwinding short positions were among those said to be buying Bear's stock last week as it traded between $2.84 and $8.50.

The average daily volume traded in Bear's stock over the last 10 days was 96.6 million shares -- nearly equal to Bear's free float of 110 million shares. March 14 saw the biggest spike in volume, with 187 million shares changing hands.

"It would seem those who ... stepped into those shares anywhere between $2 and $5 have obviously done very well," said John Augustine, chief investment strategist with Fifth Third investment advisors. "You now have a whole another set coming in at $10 to $13 a share that wants to do equally as well. Their chances of being equally rewarded are materially less, given the structure of the deal."

Of course, for every winner, there's a loser. It is quite possible that some Bear stockholders sold out last week, thinking that getting $3 or so was the best they could do.

They may have an opportunity to recover the difference, said class action lawyer Roger Kirby at Kirby McInerney & Squire. He said he has been approached by Bear shareholders, but not filed any litigation.

But to do that, it would have to be proven that someone at JPMorgan or Bear had known the initial bid was "just testing which way the market wind could blow and they had a backstop plan" to increase, he said.

JPMorgan Chase & Co on Monday increased its offer price to

$10.

Short-term traders are now likely to own a hefty amount of Bear's stock, although it is hard to say how much. The estimates are anecdotal: one trader said short-term traders could hold anywhere from 30 to 70 percent of the stock. Two other traders estimated more than 50 percent.

Accurate data about the shareholder base is only likely to be known when a shareholder vote is scheduled and a record date -- the cut-off date for investors to own shares if they want to vote on the deal -- is set.

UNUSUAL CROWD?

The buyers of Bear Stearns' stock over the past week were seen by some as an unusual mix.

Typically arbitragers, who make money trading the spread between a deal's offer price and the price the company's shares are trading, pile in.

But the Bear Stearns deal wasn't a typical transaction, with shareholders offered a fraction of the company's previous share price and the Federal Reserve underwriting the deal.

"It's my feeling that there hasn't been a lot of the price action you'd usually see attributed to arbitrage traders," said Peter Lobravico, vice president of risk arbitrage sales/trading at Wall Street Access. "Arbs are very risk averse right now."

Some arbitrage traders have likely been stung by deals such as the leveraged buyout of SLM Corp falling apart. Some have their hands full nervously trading the $20 billion buyout of U.S. radio operator Clear Channel Communications Inc that has yet to close.

Traders cited bondholders as likely buyers of the company's stock over the past week on the theory that they were trying to gain voting rights on the deal in order to push it through.

Bear Stearns' 7.25 percent bond due 2018 rose 3.5 cents on the dollar to 97.5 cents, according to MarketAxess. It fell to a low of 79 cents on the dollar on March 14.

The cost to insure Bear Stearns' debt fell significantly on Monday, indicating credit investors' increased confidence that the deal would go through.

Credit default swaps fell to 190 basis points, or $190,000 per year for five years to insure $10 million in debt, after trading at 365 basis points on Thursday, according to broker Phoenix Partners Group. Credit default swaps on JPMorgan are trading at 90 basis points, Phoenix data shows.

Traders covering previous short positions were also likely to have been buyers of the stock, said one trader who asked for anonymity because he was not authorized to speak with the media.

Investors who sell securities "short" borrow shares, then sell them, waiting for the stock to fall so they can buy the shares at the lower price, return them to the lender and pocket the difference.

Short sellers were likely buying stock last week to close out their positions and take profits on the gigantic fall in Bear's share price.

(Reporting by Megan Davies; Additional reporting by Karen Brettell, Jui Chakravorty and Emily Chasan in New York; Jessica Hall in Philadelphia)

(Editing by Richard Chang, Leslie Gevirtz)