Unusual buying of bullish options in prepaid wireless carrier Leap Wireless International Inc LEAP.O before a takeover bid by AT&T (T.N) was announced on Friday has raised questions that the news may have reached investors ahead of time.
Average daily option volume in Leap options is 1,320 contracts traded over the last three months.
But during Friday's trading session, option volume on Leap surged to 7,139 contracts, of which only 350 were puts, resulting in a call-to-put ratio of 20 to 1, according to options analytics firm Livevol based in San Francisco. Traders focused on Leap calls that were above the value of the stock, several options participants said.
"Based on the unusually high volume of options traded and the out-of-the-money calls that were purchased on Friday, it appears that prior knowledge of this takeover may have been leaked and traded on," said Ophir Gottlieb, managing director of Livevol.
Under the merger agreement, AT&T will acquire all of Leap's stock and approximately 5 million subscribers for $15 per share in cash or about $1.2 billion. The offer represents a premium of 88 percent to Leap's Friday closing price of $7.98.
Traders typically buy out-of-the-money calls because they can put the least amount of money at risk and realize the highest return if a merger announcement is made.
A particularly aggressive trade involved 1,300 July $9 strike Leap calls purchased for about 10 cents per contract, or a premium payment of $13,000, Gottlieb said.
As of after hours trading, with the stock trading at $16.80, those calls are in the money by $7.80. In addition, Gottlieb noted that 1,400 August $9 strike calls were purchased for an average price of 40 cents per contract and are at least $7.80 in the money based on after hours stock trading.
Owners of calls, contracts which allow them to buy the company's shares at a fixed price by a certain date, benefit because the value of the call option goes up as the stock rises. A put conveys the right to sell the stock at a preset price.
AT&T and Leap did not announce their deal until after the stock market closed. The flurry in option trading in a target company's options could be speculative. But the timing of large options trades on Leap while the markets were still open raised eyebrows among some option participants.
Around 2:30 p.m. ET, the buying started in the August $9 strike calls and in the July $9 calls, trading started at 3:42 p.m. ET for about 9 to 10 cents per contracts, according to data from Trade Alert, an options analytics firm.
"It looks pretty clear that somebody caught wind of the deal," said Trade Alert president Henry Schwartz.
Livevol's Gottlieb said he was struck by the unusual volume during a three-minute window - 3:42 p.m. to 3:45 p.m., just 15 minutes before the close - in the July $9 strike calls.
"It indicates that a single trader may have been trying to hide his large trades by breaking it into smaller sizes," Gottlieb said.
A spokesman for exchange operator CBOE Holdings said the CBOE's Department of Market Regulation reviews unusual activity on a regular basis but does not comment on specific investigations. The U.S. Securities and Exchange Commission, which looks into unusual stock and option trading, did not immediately respond to an email from Reuters. A Leap spokesman declined to comment on the options activity.
In a number of recent cases, bullish bets in U.S. options ahead of several takeover announcements have raised red flags that investors may have been tipped off. The SEC has moved quickly, obtaining emergency orders to keep traders from cashing in by freezing their accounts.
The SEC last week filed a lawsuit accusing unnamed defendants of insider trading in Onyx Pharmaceuticals Inc call options before the drugmaker publicly rejected a takeover bid by larger rival Amgen Inc and put itself up for sale.
The U.S. regulator last month obtained a court order freezing the assets of a Thailand-based trader, saying he reaped $3.2 million in illegal profits after getting a tip ahead of the announcement that a Chinese meat company was buying U.S. pork producer Smithfield Foods Inc.
In February, the SEC won a freeze on a Swiss account linked to suspicious trading in H.J. Heinz Co call options before the ketchup maker was bought by Warren Buffett's Berkshire Hathaway Inc and Brazilian firm 3G Capital.
(Editing by Mohammad Zargham)