3Com trades a red flag in sensitive environment

By Doris Frankel

CHICAGO (Reuters) - Will they ever learn?

One might think that pictures of hedge fund managers and executives in handcuffs from the Galleon and other recent insider trading cases would act as a deterrent to using material insider information to trade.

Yet someone piled into 3Com Corp's (COMS.O) bullish options only hours before Hewlett-Packard Co (HPQ.N) announced late on Wednesday it was buying the network equipment company at a big premium, raising suspicion that the news was leaked.

During Wednesday's trading session, 8,085 3Com call options, which can be used as a bet that a stock will rise to a certain price by a certain date, traded against only six put options, which are often used as bearish bets on a stock. The stock gained more than 5 percent to $5.69 on that day.

That's a ratio of 1,348 to one, an almost unfathomable ratio in terms of bullishness. The 8,000-plus call options amounted to 17 times the recent average daily call volume, according to option analytics firm Trade Alert, and the buyer stands to profit handsomely if the deal is consummated.

Options traders say an investigation by U.S. regulators could be in the offing.

"He might be a lucky speculator or just foolish," said Michael Schwartz, chief options strategist at Oppenheimer & Co.

"An experienced trader would not use inside information in the options market in the current investigative environment."

Indeed. The authorities do seem to have their act together when the behavior is obvious -- take the Perot Systems case announced only two days after the Dell takeover news.

The U.S. Securities and Exchange Commission on September 23 charged a Texas man with insider trading. The agency alleged he reaped $8.64 million of illegal profit related to Dell Inc's (DELL.O) planned purchase of Perot Systems Corp PER.N after the offer was announced on September 21.

U.S. authorities are also probing the largest hedge fund insider trading case that has so far ensnared the Galleon Group hedge fund, other fund managers, Silicon Valley executives, traders and lawyers.

TRADING OPTIONS ON RUMORS

When it comes to deal activity, the line between speculation and trading on insider information blurs in the options market.

Trading any security on inside information is illegal. But trading on rumors is legal, and investors are attracted to options for their low cost, leverage and limited risk.

Rumors have a way of feeding on themselves, however.